Public Pensions Frequently Change Their Private Equity Benchmarks. Why It Matters.

Beating or missing return expectations can affect how pension boards determine a plan’s asset allocation.


Illustration by II

As public pensions have put more money into private equity, many have been working to identify benchmarks that will measure their successes and failures fairly.

Pension funds could compare their private equity portfolio’s performance to what they would have earned in public markets, which would clarify the value of paying fees and carry. At the opposite end of the spectrum, pensions could choose a private equity index, which ostensibly would allow them to compare their managers to peers.

But there’s a more fundamental problem. According to new research, the benchmarking approach a pension uses tends to change after they bring in new external consultants — which public plans do often. The researchers found that these changes often lead to pensions choosing benchmarks that are easier to beat than the measures they had been using.

This matters: Beating or missing return expectations can affect how pension boards determine the plan’s asset allocation. Consultants, meanwhile, gain more business when their pension clients beat the benchmarks.

Researchers Niklas Augustin and Matteo Binfare from the University of Missouri at Columbia and Elyas D. Fermand at Santa Clara University set out to learn more. They used data from the Center for Retirement Research at Boston College, including information on public pension funds’ size, investment performance, consultants, and other factors. They tracked this data from 2001 through 2021 at 210 pension plans, encompassing most of the United States pension universe.

They found that two-thirds of public pension funds use a public market index, usually the S&P 500 or the Russell 3000. Beating the benchmark by about 3 percent is often the bar for success. Roughly a quarter of pension funds use private equity benchmarks, like the Cambridge Associates US Private Equity index. Others use customized benchmarks.


So why do benchmarks change? Public pension plans are often subject to state laws or internal policies that require them to run a search for consultants every so many years. This assessment naturally leads to turnover.

The researchers found that after a pension plan changes its general consultant, they are 8 percent more likely to change a benchmark in the following two years.

This is a boon to the consulting industry. “Our findings support this conjecture: consultants who change benchmarks are more likely to secure additional consulting contracts in the following years, allowing them to manage more assets for institutional investors,” according to the paper.

According to the paper, over the 20-year sample period, pensions outperformed the new benchmarks by about 1.7 percentage points a year, 300 percentage points cumulatively.

“Consequently, benchmarks have become increasingly easier to beat over time, and this trend holds true across all pension funds,” the paper said.

But the trend may not be apparent at first.

In the year that a benchmark change takes place, the average reported private equity return is 4.44 percentage points higher than the year prior. The benchmark itself increases by 3.67 percentage points for the same time period. This is, in part, due to timing. Public pensions tend to change their benchmarks following a recessionary period — usually around the time that they fire a consultant.

While the characteristics of a benchmark for private equity returns don’t affect the actual performance, the hurdle does influence how much money gets invested in the asset class, the researchers found. “Instead, they likely serve as performance hurdles guiding the strategic decision-making process between public and private equity allocation at the policy (i.e., strategic) level,” the paper said.