Are public pension funds really delivering the returns they declare? The hole between personal asset internet asset values (NAVs) and their actual market worth, a phenomenon often called volatility laundering, reveals important implications for institutional buyers. With personal property usually overstated by as a lot as 12%, public pension funds could face higher underperformance than reported. This put up explores how the apply of volatility laundering distorts returns and why transparency in personal asset valuation is extra important than ever for public pension funds in the US.
State of Play
By conference, personal property like unlisted actual property and personal fairness are carried at their NAV within the valuation of institutional funds and within the calculation of their charges of return. NAV is a determine arrived at by the final companions (GPs) of personal asset funds and reviewed by their accountants.[1]
In recent times, a niche opened between private-asset values within the secondary market and their NAVs. The hole persists right now.[2] {The marketplace} is telling us that these personal property are usually not price what the GPs and their accountants say they’re price. Cliff Asness coined the time period volatility laundering to explain the apply of not marking personal property to market.
Public Fund Efficiency with Reported Returns
I acquired charges of return for a pattern of fifty giant US public pension funds for the 16 fiscal years ended June 30, 2024. The sources are the Heart for Retirement Analysis at Boston School (CRR) and the funds’ annual reviews. I included solely funds reporting returns internet of charges.
I then created an equal-weighted composite of fund returns and developed a Market Index to judge the efficiency of the composite. The Market Index has the identical efficient stock-and-bond market exposures and the identical threat (normal deviation of complete return) because the composite. The Market Index blends returns of US- and non-US inventory indexes with these of an investment-grade US bond index to type a single, hybrid index.[3]
The composite has an annualized return of 6.88% for the 16 years, and the Market Index return is 7.84%. The distinction between the 2 sequence, or annual extra return (ER), is -0.96%. See Exhibit 1.
Exhibit 1. Historic Returns Fiscal Years 2009 to 2024.
|  Fiscal 12 months |  Public Fund Composite |  Market Index |  Extra  Return |
| 2009 | -19.8 | -17.5% | -2.2% |
| 2010 | 13.7 | 13.0 | 0.7 |
| 2011 | 21.5 | 22.6 | -1.1 |
| 2012 | 1.1 | 1.7 | -0.6 |
| 2013 | 12.0 | 13.9 | -1.9 |
| 2014 | 16.8 | 18.2 | -1.5 |
| 2015 | 3.3 | 4.% | -1.0 |
| 2016 | 0.6 | 0.9 | -0.3 |
| 2017 | 12.7 | 13.6 | -0.9 |
| 2018 | 8.8 | 9.1 | -0.3 |
| 2019 | 6.4 | 7.3 | -0.9 |
| 2020 | 2.2 | 5.2 | -3.0 |
| 2021 | 27.1 | 29.4 | -2.3 |
| 2022 | -3.8 | -13.3 | 9.5 |
| 2023 | 6.7 | 12.2 | -5.5 |
| 2024 | 9.4 | 15.4 | -6.1 |
| Annualized | 6.88% | 7.84% | -0.96% |
Secondary Market Pricing
In fiscal 12 months 2022, an unusually giant hole — 950 foundation factors (bps) — between the general public fund composite return and that of the Market Index appeared. The common ER within the prior 13 years was simply -1.2%. See Exhibit 1. Inventory and bond markets skilled a pointy decline late in fiscal 12 months 2022.
NAVs reported by GPs of personal asset partnerships, nevertheless, usually lag public market reporting by 1 / 4 or extra. The lag in reporting NAVs produced giant optimistic returns for personal property in fiscal 12 months 2022, regardless of the sell-off in shares and bonds. This unleashed a sequence of NAV changes by fund managers within the years following to deliver marks into conformance with market realities. (See fiscal years 2023 and 2024 in Exhibit 1.)
{The marketplace}, nevertheless, believes the GPs and their accountants have extra work to do in marking personal property to market. This commentary relies on knowledge from the secondary marketplace for personal asset transactions. The info in Exhibit 2 had been compiled by Jeffries’s Non-public Capital Advisory unit. Exhibit 2 summarizes the reductions from NAV for varied classes of personal property through the first half of 2024.
Exhibit 2. NAV Reductions for Non-public Belongings.
| Â Â Â Asset Kind | Â First Half of 2024 |
| Buyout | 6% |
| Credit score | 15 |
| Actual Property | 26 |
| Enterprise | 30 |
| All | 12% |
Supply: Jeffries Non-public Capital Advisory
Within the evaluation that follows, I incorporate the general low cost of 12% for personal asset transactions within the first half of 2024 in estimating pension fund returns that mirror truthful market pricing.
The Heart for Retirement Analysis reviews that public funds allotted a median of 24% to personal property (personal fairness and actual property, solely) by way of fiscal 12 months 2022. I multiply the personal asset proportion of 24% by the common NAV low cost of 0.12, which produces a determine of two.9%. Assuming Jeffries’s general low cost applies, this means that the funds, within the mixture, had been over-valued by roughly 3% relative to the market.
I apply this adjustment to the surplus return determine of -0.96%. I do that by dividing 3% by 16 (years), producing a 0.2% (18 bps, to be exact) haircut to extra return. (If we unfold the haircut over the latest 10 years, it quantities to 0.3% per 12 months. The interval chosen for making use of the haircut is bigoted. This leads to an adjusted extra return (AER) of -1.14% per 12 months since fiscal 12 months 2009. See Exhibit 3. The calculations are tough and prepared however ok to get the concept throughout.
Exhibit 3. Recap of Calculation of Adjusted Extra Return.
| Measure | Annualized Returns | |
| Reported Return | 6.88% | Â |
| Market Index | -7.84 | Â |
| Extra Return (ER) | -0.96% | -0.96% |
| Non-public Belongings Haircut | Â | -0.18 |
| Adjusted Extra Return (AER) | Â | -1.14% |
Key Takeaway
Public pension funds have underperformed a public market index by roughly one proportion level per 12 months because the World Monetary Disaster. I attribute this to their excessive value of operation and inefficient diversification.
Volatility laundering — the apply of not marking personal property to market — obscures one other dimension of financial underperformance of those funds. Had been public funds to mark personal property to market, it might deliver a couple of two- or three-tenths of a proportion level per 12 months worsening of their long-term efficiency — a success they will unwell afford.
[1] ASC 820, adopted by FASB in 2008, offers steerage on truthful market valuation of personal property.
[2] Jeffries reviews reductions for a basket of personal property traded within the secondary market fluctuated between 8% and 19% between 2018 and 2024.
[3] The Market Index includes the Russell 3000 inventory index (52%), MSCI ACWI ex-US shares (19%), and Bloomberg US Combination bond index (29%). The R2 of the general public fund composite with the Market Index is 99.3% for the 13 years ended June 30, 2021, with a wee monitoring error of 1.0%.
Are public pension funds really delivering the returns they declare? The hole between personal asset internet asset values (NAVs) and their actual market worth, a phenomenon often called volatility laundering, reveals important implications for institutional buyers. With personal property usually overstated by as a lot as 12%, public pension funds could face higher underperformance than reported. This put up explores how the apply of volatility laundering distorts returns and why transparency in personal asset valuation is extra important than ever for public pension funds in the US.
State of Play
By conference, personal property like unlisted actual property and personal fairness are carried at their NAV within the valuation of institutional funds and within the calculation of their charges of return. NAV is a determine arrived at by the final companions (GPs) of personal asset funds and reviewed by their accountants.[1]
In recent times, a niche opened between private-asset values within the secondary market and their NAVs. The hole persists right now.[2] {The marketplace} is telling us that these personal property are usually not price what the GPs and their accountants say they’re price. Cliff Asness coined the time period volatility laundering to explain the apply of not marking personal property to market.
Public Fund Efficiency with Reported Returns
I acquired charges of return for a pattern of fifty giant US public pension funds for the 16 fiscal years ended June 30, 2024. The sources are the Heart for Retirement Analysis at Boston School (CRR) and the funds’ annual reviews. I included solely funds reporting returns internet of charges.
I then created an equal-weighted composite of fund returns and developed a Market Index to judge the efficiency of the composite. The Market Index has the identical efficient stock-and-bond market exposures and the identical threat (normal deviation of complete return) because the composite. The Market Index blends returns of US- and non-US inventory indexes with these of an investment-grade US bond index to type a single, hybrid index.[3]
The composite has an annualized return of 6.88% for the 16 years, and the Market Index return is 7.84%. The distinction between the 2 sequence, or annual extra return (ER), is -0.96%. See Exhibit 1.
Exhibit 1. Historic Returns Fiscal Years 2009 to 2024.
|  Fiscal 12 months |  Public Fund Composite |  Market Index |  Extra  Return |
| 2009 | -19.8 | -17.5% | -2.2% |
| 2010 | 13.7 | 13.0 | 0.7 |
| 2011 | 21.5 | 22.6 | -1.1 |
| 2012 | 1.1 | 1.7 | -0.6 |
| 2013 | 12.0 | 13.9 | -1.9 |
| 2014 | 16.8 | 18.2 | -1.5 |
| 2015 | 3.3 | 4.% | -1.0 |
| 2016 | 0.6 | 0.9 | -0.3 |
| 2017 | 12.7 | 13.6 | -0.9 |
| 2018 | 8.8 | 9.1 | -0.3 |
| 2019 | 6.4 | 7.3 | -0.9 |
| 2020 | 2.2 | 5.2 | -3.0 |
| 2021 | 27.1 | 29.4 | -2.3 |
| 2022 | -3.8 | -13.3 | 9.5 |
| 2023 | 6.7 | 12.2 | -5.5 |
| 2024 | 9.4 | 15.4 | -6.1 |
| Annualized | 6.88% | 7.84% | -0.96% |
Secondary Market Pricing
In fiscal 12 months 2022, an unusually giant hole — 950 foundation factors (bps) — between the general public fund composite return and that of the Market Index appeared. The common ER within the prior 13 years was simply -1.2%. See Exhibit 1. Inventory and bond markets skilled a pointy decline late in fiscal 12 months 2022.
NAVs reported by GPs of personal asset partnerships, nevertheless, usually lag public market reporting by 1 / 4 or extra. The lag in reporting NAVs produced giant optimistic returns for personal property in fiscal 12 months 2022, regardless of the sell-off in shares and bonds. This unleashed a sequence of NAV changes by fund managers within the years following to deliver marks into conformance with market realities. (See fiscal years 2023 and 2024 in Exhibit 1.)
{The marketplace}, nevertheless, believes the GPs and their accountants have extra work to do in marking personal property to market. This commentary relies on knowledge from the secondary marketplace for personal asset transactions. The info in Exhibit 2 had been compiled by Jeffries’s Non-public Capital Advisory unit. Exhibit 2 summarizes the reductions from NAV for varied classes of personal property through the first half of 2024.
Exhibit 2. NAV Reductions for Non-public Belongings.
| Â Â Â Asset Kind | Â First Half of 2024 |
| Buyout | 6% |
| Credit score | 15 |
| Actual Property | 26 |
| Enterprise | 30 |
| All | 12% |
Supply: Jeffries Non-public Capital Advisory
Within the evaluation that follows, I incorporate the general low cost of 12% for personal asset transactions within the first half of 2024 in estimating pension fund returns that mirror truthful market pricing.
The Heart for Retirement Analysis reviews that public funds allotted a median of 24% to personal property (personal fairness and actual property, solely) by way of fiscal 12 months 2022. I multiply the personal asset proportion of 24% by the common NAV low cost of 0.12, which produces a determine of two.9%. Assuming Jeffries’s general low cost applies, this means that the funds, within the mixture, had been over-valued by roughly 3% relative to the market.
I apply this adjustment to the surplus return determine of -0.96%. I do that by dividing 3% by 16 (years), producing a 0.2% (18 bps, to be exact) haircut to extra return. (If we unfold the haircut over the latest 10 years, it quantities to 0.3% per 12 months. The interval chosen for making use of the haircut is bigoted. This leads to an adjusted extra return (AER) of -1.14% per 12 months since fiscal 12 months 2009. See Exhibit 3. The calculations are tough and prepared however ok to get the concept throughout.
Exhibit 3. Recap of Calculation of Adjusted Extra Return.
| Measure | Annualized Returns | |
| Reported Return | 6.88% | Â |
| Market Index | -7.84 | Â |
| Extra Return (ER) | -0.96% | -0.96% |
| Non-public Belongings Haircut | Â | -0.18 |
| Adjusted Extra Return (AER) | Â | -1.14% |
Key Takeaway
Public pension funds have underperformed a public market index by roughly one proportion level per 12 months because the World Monetary Disaster. I attribute this to their excessive value of operation and inefficient diversification.
Volatility laundering — the apply of not marking personal property to market — obscures one other dimension of financial underperformance of those funds. Had been public funds to mark personal property to market, it might deliver a couple of two- or three-tenths of a proportion level per 12 months worsening of their long-term efficiency — a success they will unwell afford.
[1] ASC 820, adopted by FASB in 2008, offers steerage on truthful market valuation of personal property.
[2] Jeffries reviews reductions for a basket of personal property traded within the secondary market fluctuated between 8% and 19% between 2018 and 2024.
[3] The Market Index includes the Russell 3000 inventory index (52%), MSCI ACWI ex-US shares (19%), and Bloomberg US Combination bond index (29%). The R2 of the general public fund composite with the Market Index is 99.3% for the 13 years ended June 30, 2021, with a wee monitoring error of 1.0%.
