Corporate Pension Plan Investments in Alternative Assets: Determinants and Consequences

WP#2011-13

Abstract

I examine the determinants and consequences of corporate pension plan investments in hedge funds and private equity, commonly referred to as ‘alternative assets’. I find that highly leveraged firms with low market-to-book ratios and volatile earnings performance are more likely to invest in alternative assets, indicating that financially constrained firms choose alternative investments to increase asset returns and minimize pension contributions. I also find a nonlinear relationship between plan funding status and alternative investing – very underfunded and well-funded plans are less likely to make alternative investments compared to moderately underfunded plans, suggesting that such plan sponsors may avoid these investments to minimize contribution volatility. I find that plans with alternative investments earn higher returns in the pre-crisis period, but also perform more poorly during the crisis period, suggesting that the potential diversification benefits from investing in this asset category may be overstated.

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