If you are trying to figure out an asset allocation to use in your own portfolio, pension funds are good places to look for ideas. In fact, some experts suggest that individual investors would be wise to follow the lead of the pension plans. The reasons are pretty simple if you think about it.
First, pension plans are invested for the best balance between risk and reward. The cannot be too risk adverse, or they run the risk of not being able to meet the future withdrawal requirements of the fund that it’s participants will require when they retire. They also cannot take on too much risk, or they run the risk of the portfolio blowing up and once again, not being able to meet the needs of future withdrawals from the fund. Thus, pension plans have invested a great amount of resources in determining what the best asset allocation is given their requirements, which leads us to the second reason investors would be wise to follow the pension plans as a guide – some of the best minds in finance work for pension plans.
The second reason for understanding what the pension plans are doing is that they employ some of the best minds in finance and their strategies are typically deeply routed in theory and best practices. These people are not the mutual fund managers that you are used to seeing – they are not sales people. Instead they are doctorates and other highly educated academics that have done complex research on what works best in investing. Since I don’t have this background or expertise, I like to look at what they are doing to learn best practices.
The Asset Allocation Research
I did some looking around the web and identified an interesting study completed by the folks at Mercer, who are a large advisory firm to human resources departments. Mercer advises on things such as compensation, benefit plans, and in our case pension plans. In one particular report (pdf) they provided a breakdown of the pension plans utilized by companies within the S&P 500. Here is what that asset allocation looks like:
As you can see, there is not an overwhelming portion of this portfolio in equities. Fixed income makes up a large component. I would like to see how these funds breakdown their equity components – domestic, global, emerging, etc. I was unable to find that detail in this report but will keep looking.
Is this a good guide for most investors? I would suggest that it is a great place to start. There are good reasons these pension plans have chosen this target asset allocation. If you are looking for additional readings on choosing the right asset allocation, be sure to take a look at William Bernstein’s books on the topic.
(Photo Credit: Steve Woods)