Should Your Portfolio Emulate Those of Pension Funds?

Alternative investments reflect new opportunities

Ric Edelman: It's Wednesday, May 15th. On today's show, the changes that pension funds are making to their investments. Pension funds are not like you and me. When you invest, it's because you're trying to come up with enough money to meet your needs for your lifetime. There's a fixed period to that timeline, a fixed amount that you're going to need. 

But pensions aren't like you. They don't die. Pension funds are forever, because when one old retiree dies, there's a younger worker who will take their place. As a result of this, an 80-year-old person might need to have very little money in stocks because they can't handle the short-term risks of a stock market crash. 

But an 80-year-old pension fund is as young as a 20-year-old worker in it. Because it's going to be around for another 100 years, just like that 20-year-old is going to be. I mention all this to you because you need to know that pension funds don't behave the same way as you and me. They have a different situation that causes them to invest with a different mindset. 

Now, all that said, it's worth looking at what pension funds are doing, because these funds are some of the biggest investors in the country. All told, pension funds at companies plus state and local governments, they manage a total of about $9 trillion, and they are all run by some of the most talented and experienced investment managers in the country. 

So let's see what they're doing these days, because there might be some messages for you and me. And guess what? Pension funds are pulling hundreds of billions of dollars from the stock market. $325 billion, according to Goldman Sachs. And they're moving that money into bonds, alternative investments, private equity, and private debt. 

This is all about trying to reduce risk while maintaining returns and opportunistically finding investments in new areas. Bottom line, they are moving about 15% of their portfolios into risky assets. CalPERS for example, that's the country's largest pension fund, the California Public Employees Retirement System. 

They just cut their stock allocation from 42% to 37%. And they're going to increase their holdings of private equity and private debt. New York's retirement fund did the same thing. They're cutting stocks from 47% to 39%. So what is private equity? What is private debt?  

You know what equity is. Equity means ownership. Ownership means shares of stocks. If you want to invest in a publicly traded company, a company whose shares are listed on the New York Stock Exchange or NASDAQ, then you buy those shares and you are an owner of the company. The more shares you own, the more of an owner you are. 

That's public equity, and this has been around for a couple of hundred years. But there's an increasingly big trend in corporate America called private equity, where investors are buying a piece of companies that are not traded daily on the New York Stock Exchange. These are companies that are privately owned, but have sold a portion of their business to private investors. 

These are called private equity firms, PE firms. These are companies like venture capitalists and hedge funds that buy a piece of companies that aren't publicly traded, but whose owners want to monetize a little bit. They want to generate a little liquidity for themselves. Maybe they want some outside capital to help them grow. 

It has gotten to the point that we now have a lot of companies. Here's the situation. If 20 years ago, you owned a company and you needed capital so that you could grow, you would sell some of your business to investors. And to raise that capital, you would go to the New York Stock Exchange or the NASDAQ, and you would sell your shares there. 

But nowadays, companies don't have to find themselves limited to the NYSE. They can instead raise the money they're seeking by going to private investors, private equity firms. These firms have amassed billions of dollars from investors, institutional investors, sovereign wealth funds, rich people, endowments and pension funds. 

And they're willing to provide the capital to these young companies so that they can grow. This allows these young companies to stay private, meaning they get to continue to have control of their businesses while gaining the capital and the resources they need from private equity firms. It's gotten to the point where 15 years ago, there were about 7,500 companies in the United States that were publicly traded. 

Their stocks were available on the New York Stock Exchange or NASDAQ. Today, there aren't 7,500 of those companies anymore. There are only about half, about 3,000 of them are publicly traded today. What happened to the rest? They were bought by private equity. So along come today's pension funds like CalPERS or the New York Retirement Fund, they aren't limited in their effort to invest in stocks, to go buy publicly traded stocks. They now have so much money themselves, they can make direct investments in the companies that are still private. Private equity.  

They're doing the same thing with private debt. In the old days, debt was issued by big companies, or it was issued by state and local governments, and if you wanted to lend your money to these organizations or these governments, you got a return on your investment. You lent money to the state of New York, or you lent money to AT&T. They paid you interest and they gave your money back at maturity. The interest you got was higher than you'd get in a treasury or a bank CD, which was the enticement for you to lend your money and buy those bonds. But nowadays, just as there are companies that are offering their equity privately, there are now companies that are offering their debt privately. 

Investment opportunities not available to ordinary investors. The point is that both private equity and private debt are in the alternatives space. Alternative investment opportunities, meaning alternatives to public stock and public bonds. And you need to look at alternatives for your own portfolio, if you're a financial advisor, for your clients as well. 

Investments in exponential technology, such as AI and robotics, Bitcoin, blockchain and digital assets. Innovative investment opportunities that didn't exist 10 years ago. You want to make sure that you and your clients have the portfolios of the future, so you're not stuck with the investments of the past. 

The nation's biggest pension funds are doing this. They are shifting out of the public markets and looking at private investment opportunities because that's where they clearly think the future opportunities exist. If you're an investor, talk with your financial advisor about these ideas, because pension funds shouldn't be ignored.  

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On tomorrow's show, housing for your aging parents. 

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