The pension money that has poured into alternative assets over the past 20 years is largely due to investment consultants’ belief that these assets would outperform — despite little evidence that has happened, according to new academic research.
The consultants convinced pensions — and their peers — that “alternatives would add alpha relative to public equities,” said Stanford Graduate School of Business associate professor Juliane Begenau and PhD candidate Pauline Liang, along with Harvard Business School’s Emil Siriwardanee, in their paper “The Rise of Alternatives.”
Dan Rasmussen, founder of Verdad Advisers, called the paper “fascinating” because it made the case that the shift into alternatives is “not the result of shifts in realized performance, liquidity needs, or macroeconomic fundamentals.” Instead, he said, “the driver was a change in the beliefs of the pension funds’ investment consultants.”
According to Rasmussen, “the sociology of belief formation — rather than pure economics — becomes central to understanding institutional portfolios in this framework.”
In their paper, the professors noted that “since the early 2000s, public pensions in the United States have substantially altered the composition of their risk assets (defined as everything except fixed income), actively reallocating away from public equities and into alternative investments like private equity, real estate, and hedge funds.”
Between 2001 and 2021, the time period the professors studied, the share of alternatives in the national portfolio increased to 30 percent from 9 percent.
That shift happened as “consultant-reported beliefs about the alpha of alternatives relative to public equities have risen steadily since the 2000s,” the authors noted. The biggest shift was in private equity, with an 88 basis point increase in expected alpha from 2003 to 2021 — the year that happened to be the top for the private equity market (and when the study ends).
But while consultants became increasingly bullish about alternatives, the asset class hasn’t outperformed an investable model global market portfolio, as measured against State Street’s GMP, which provides benchmark weights for a number of asset classes based on their market capitalization, the academics found.
“Their analysis is distinctive because it combines detailed data on public pension portfolios with consultants’ forward-looking capital market assumptions, allowing the authors to directly link shifts in asset allocation to changes in expected returns rather than realized performance,” explained Rasmussen. “This matched dataset enables a structural analysis of how belief-driven expectations — especially about alternatives — shaped institutional investment decisions.”
While the global market portfolio had increased 23 percentage points from 10 percentage points in 2001, by 2010, pensions’ alternatives weren’t matching the benchmark’s performance, the authors found. And by 2021, pensions were overweight alternatives in their risky portfolio by roughly 17 percentage points relative to the global market portfolio, according to the research.
The professors aren’t ready to call alternatives a bad investment idea, but they are cautious. “Our main takeaway from this preliminary analysis is that more work is needed to assess whether beliefs about alpha are rational,” they said. “This question is critical for assessing the welfare implications of alternatives for pension beneficiaries, especially given the costs and complexity of investing in this asset class.”
Consultants’ bullishness only accounted for about 12 percent of the increase, but it became the consensus that led to group think. The academics found that about 20 percent of the change in views came from “peers” amplifying the consultants’ views.
“This change in belief was, in many cases, self-reinforcing: as more consultants published higher expected returns for alternatives, their peer firms followed,” said Rasmussen.
He added that this type of “correlated belief” can cause financial crisis, citing work by Stanford economist Mordecai Kurz who “warned that markets dominated by agents with correlated beliefs can produce coordinated behavior even when fundamentals diverge.”
According to Rasmussen, the new academic research is “essentially an empirical demonstration of Kurz’s theory in action: as consultants updated their alphas in tandem, institutions reallocated in a highly correlated fashion.”
One important realization is that “capital market assumptions are not just inputs; they are persuasive tools,” he said. “They define the language of risk, frame the boundaries of plausibility, and legitimate allocation changes. Once alternatives were viewed as the higher-alpha option, the allocation shift became not only acceptable but expected. And once enough institutions moved, the belief in their superiority became embedded—regardless of realized performance.”
The professors also noted that pension funds’ experience in the 1990s, when they were first allowed to invest in the stock market, may also have played a part. That experience was marked by two stock market crashes, in both 2000 and 2008.
Yet pension funds have not become more risk-averse over time. Another finding is that alternatives are part of pension funds’ shifts into more risky assets—and out of fixed income. “For every dollar that shifted out of fixed income since 2001, $2.72 has moved into alternatives and $1.72 has flown out of public equities,” they said.
He said the important part of the research is that “expectations, especially when widely shared and mutually reinforced, can shape capital markets just as powerfully as fundamentals.”
