Why do pension funds invest

Regardless of whether or not the managers of Allianz "Structured Alpha" portfolios were following their own promised strategy, what on Earth are these pension fund managers doing investing in these hedge funds anyway? Hedge funds are a terrible investment. Absolutely terrible. The few funds that really know how to beat the market have little incentive to invite outside investors because, because, well, why would they?

If I know how to beat the market by a wide margin every year, why on Earth would I go around giving my profits away to other people? Renaissance Technologies' Medallion Fund, the superstar of funds, hasn't wanted your money for nearly 30 years link. It's really not complicated. Most hedge funds are brilliant vehicles designed to make their managers rich.

That doesn't mean they're doing anything illegal, or maybe even unethical. It's capitalism. Only with hedge funds, you don't even get the car or the bag. In other words, as an investor, you're not going to get ahead of the game at all in the average hedge fund unless the managers can do as well as stock and bonds, and half as much again, year after year. The Allianz fund, incidentally, had a different fee structure, but was designed to take big risks.

If you don't believe me, check out the industry numbers. Through the end of August this year, stocks were up and bonds were up--big time. So you were making out like a bandit on your insurance as well as your "risky" stocks. As an example of the prevalence of fixed-income securities in pension portfolios, the largest pension plan in the U.

Equity investments in U. The search for higher returns has pushed some fund managers into riskier small-cap growth stocks and international equities. Smaller funds are likely to seek outside management—or else invest in institutional versions of the same mutual funds and exchange traded funds ETFs as individual investors. The prime difference here is that the institutional share classes do not have front-end sales commissions, redemption, or 12b-1 fees, and they charge a lower expense ratio.

Institutional investors, such as pension funds, and those classified as accredited investors invest in private equity—a long-term, alternative investment category suited for sophisticated investors. In fact, pension funds are one of the largest sources of capital for the private equity industry.

In its purest form, private equity represents managed pools of money invested in the equity of privately-held companies with the intention of eventually selling the investments for substantial gains. Private-equity fund managers charge high fees based on promises of above-market returns. The amount of assets managed by public and private-sector pension plans in the U. Pension fund real estate investments are typically passive investments made through real estate investment trusts REITs or private equity pools.

Some pension funds run real estate development departments to participate directly in the acquisition, development, or management of properties. Long-term investments are in commercial real estate , such as office buildings, industrial parks, apartments, or retail complexes. The goal is to create a portfolio of properties that combine equity appreciation with a rising stream of inflation -adjusted income to balance the ups and downs of the markets.

Infrastructure investments remain a small part of most pension-plan assets, but they are a growing market of a diverse assortment of public or private developments involving power, water, roads, and energy. Public projects experience limitations due to budgets and the borrowing power of civil authorities. Private projects require large sums of money that are either expensive or difficult to raise.

Pension plans can invest with a longer-term outlook and the ability to structure creative financing. Typical financial arrangements include a base payment of interest and capital back to the fund, along with some form of revenue or equity participation. A toll road might pay a small percentage of tolls in addition to the financing payment. A power plant might pay a little bit for every megawatt generated and a percentage of the profits if another company buys the plant.

Inflation protection is a term used to refer to assets that tend to go up in value as inflation ramps up. These may include inflation-adjusted bonds e. TIPS , commodities, currencies, and interest-rate derivatives. The use of inflation-adjusted bonds is often justified, but the increased allocation of pension fund assets in commodities, currencies, or derivatives has raised concerns by some due to the additional idiosyncratic risk that they carry.

Liability matching , also known as " immunization ", is an investment strategy that matches future assets sales and income streams against the timing of expected future expenses. The strategy has become widely embraced among pension fund managers, who attempt to minimize a portfolio's liquidation risk by ensuring asset sales, interest, and dividend payments correspond with expected payments to pension recipients.

This stands in contrast to simpler strategies that attempt to maximize return without regard to withdrawal timing. As an example, retirees living off the income from their portfolios generally rely on stable and continuous payments to supplement social security payments. A matching strategy would involve the strategic purchase of securities to pay out dividends and interest at regular intervals.

Ideally, a matching strategy would be in place well before retirement years commence. A pension fund would employ a similar strategy to make sure its benefit obligations are met.

Pension funds make promises to their participants, guaranteeing them a certain level of retirement income in the future. This means they have to be relatively conservative in terms of risk, but also achieve sufficient returns to cover those guarantees. Urban Institute. Bureau of Labor Statistics. Accessed March 18, Pension Rights Center. National Association of State Retirement Administrators. Pension Benefit Guarantee Corporation. Pension Benefit Guaranty Corporation. Government Publishing Office.

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Your Practice. Popular Courses. Retirement Planning Pensions. Table of Contents Expand. How Pension Funds Work. The State of Pension Funds Today. Key Takeaways Traditional defined-benefit pension plans are vanishing from the retirement landscape, especially among private employers, but many still exist. Pension plans are funded by contributions from employers and occasionally from employees.

Public employee pension plans tend to be more generous than ones from private employers. Private pension plans are subject to federal regulation and eligible for coverage by the Pension Benefit Guaranty Corporation. Article Sources. Investopedia requires writers to use primary sources to support their work. These include white papers, government data, original reporting, and interviews with industry experts.