Conventional wisdom says that alternative investments buoy a portfolio’s return and offer broader diversification than a combination of stocks and bonds. But according to an analysis by the Center for Retirement Research at Boston College (CRR), only half of that is actually true, at least where public pensions are concerned.

The analysis brief, Public Pension Investment Update: Have Alternatives Helped or Hurt?, found that the investment performance of public pension funds from 2001 to 2022 has averaged only 5.9%, despite increasingly larger allocations to the private equity, hedge funds, real estate and commodities that make up the alternative assets class.

“Overall, state and local plans have increased their holdings from 9% in 2001 to 34% in 2022,” wrote Jean-Pierre Aubry, associate director of state and local research at CRR and the brief’s author. “Not only have alternatives become a much larger share of public plans’ portfolios, but their composi­tion has also changed.”

Whereas private equity has always accounted for around a third of alternative investment, the brief said, the allocation to real estate has dropped from 56% in 2001 to 34% in 2022, while the percentage earmarked for hedge funds and commodities has risen to 18% from 4% and to 14% from 2%, respectively.

To ascertain whether alternatives investing helps or hurts a portfolio, CCR looked at the returns for a broad indices of alternatives and traditional equities before, during and after the Global Financial Crisis.

What it found was the asset class substantially outperformed traditional equities from 2001 to 2007, averaging about 14% returns compared to equities’ 5%. And other than real estate, alternatives lost much less than equities during the financial crisis—private equity lost 13%, hedge funds 4.4% and commodities 4.1%, compared to equities, which lost 21.7%. The outlier was real estate, which lost 31.2%. So a good stretch where alternatives performed better in good times and lost less in bad times, the brief said.

“However, since the crisis, the performance of alternatives has been more mixed, with private equity and real estate rebounding somewhat, while hedge funds and commodities continue to provide lower returns,” Aubry wrote. “From 2010 to 2022, both hedge funds and commodities performed less well than equities, [and] the ef­fects of private equity and real estate are not statisti­cally significant over this period, suggesting that—at least since 2010—some plans could have done just as well by investing in traditional equities.”

Aubry’s analysis found that from 2010 to 2022, holding 10% more of a portfolio in alternatives was associated with a 33-basis-point decrease in the return relative to traditional equities.

But Aubry also found that pension plans with greater allocations to alternatives saw less volatility since 2010—48.1 basis points less. No one or two specific kind of investment was more responsible for this than the others, he wrote. “Each asset class contributed to a reduction in volatility—but it is difficult to tease out the effect of one asset class from another.”

In the final analysis, CCR’s research found that even though pension plans have allocated increasing amounts of their portfolios to alternative assets, this has not helped the plans in their quest for better performance to help them fill their obligations. In fact, their performance remains below their actuarial expectations. But the presence of alternative assets in a portfolio has seemed to dampen volatility, the brief said.