DEFINED BENEFIT 

PENSION PLANS

Recent Developments 

Highlight Challenges 

of Hedge Fund and 

Private Equity 

Investing

Report to the Ranking Member, 

Subcommittee on Health, Employment, 

Labor, and Pensions, Committee on 

Education and the Workforce, House of 

Representatives

February 2012

GAO-12-324

United States Government Accountability Office

GAO
United States Government Accountability Office

Highlights of GAO-12-324, a report to the 

Ranking Member, Subcommittee on Health, 

Employment, Labor, and Pensions, Committee 

on Education and the Workforce, House of 

Representatives

February 2012

DEFINED BENEFIT PENSION PLANS

Recent Developments Highlight Challenges of Hedge 

Fund and Private Equity Investing

Why GAO Did This Study

Millions of Americans rely on defined 

benefit pension plans for their financial 

well-being in retirement. Plan 

representatives are increasingly 

investing in a wide range of assets, 

including hedge funds and private 

equity funds. In recent years, GAO has 

noted that plans may face significant 

challenges and risks when investing in 

these alternative assets. These 

challenges and ongoing market 

volatility have raised concerns about 

how these investments have 

performed since 2008.

As requested, to better understand 

plan sponsors’ experiences with these 

investments, GAO examined (1) the 

recent experiences of pension plans 

with investments in hedge funds and 

private equity, including lessons 

learned; (2) how plans have responded 

to these lessons; and (3) steps federal 

agencies and other entities have taken 

to help plan sponsors make and 

manage these alternative investments.

To answer these questions, GAO 

analyzed available data; interviewed 

relevant federal agencies and industry 

experts; conducted follow-up 

interviews with 22 public and private 

pension plan sponsors selected among 

the top 200 plans and contacted in the 

course of GAO’s prior related work; 

and surveyed 20 plan consultants, 

academic experts and other industry 

experts.

This report reemphasizes a 2008 

recommendation that the Secretary of 

Labor provide guidance to help plans 

investing in hedge funds and private 

equity.

What GAO Found

While plan representatives GAO contacted generally stated that their hedge fund 

and private equity investments met expectations in recent years, a number of 

plans experienced losses and other challenges, such as limited liquidity and 

transparency. National data indicated that hedge fund and private equity 

investments were significantly affected by the 2008-2009 financial crisis, and 

plans and experts GAO contacted indicated that pension plan investments were 

not insulated from losses. Most of the 22 plan representatives GAO interviewed 

said that their hedge fund investments met expectations overall, despite, in some 

cases, significant losses during the financial crisis. A few plan representatives, 

however, expected hedge fund investments to be much more resilient in 

turbulent markets, and found the losses disappointing. Given the long-term

nature of private equity investments, almost all of the representatives were 

generally satisfied with these investments over the last 5 years. Some plan 

representatives described significant difficulties in hedge fund and private equity 

investing related to limited liquidity and transparency, and the negative impact of 

the actions of other investors in the fund—sometimes referred to as co-investors. 

For example, representatives from one plan reported they were unable to cash 

out of their hedge fund investments due to discretionary withdrawal restrictions 

imposed by the fund manager, requiring them to sell some of their stock holdings 

at a severe loss in order to pay plan benefits.

Most plans included in our review have taken actions to address challenges 

related to their hedge fund and private equity investments, including allocation 

reductions, modifications of investment terms, and improvements to the fund 

selection and monitoring process. National data reveal that plans have continued 

to invest in hedge funds and private equity—for example, one survey revealed 

that the percentage of large plans investing in hedge funds grew from 47 percent 

in 2007 to 60 percent in 2010—and most plans GAO contacted have also 

maintained or increased their allocations to these investments. However, most 

plans have adjusted investment strategies as a result of recent years’ 

experiences. For example, three plans have reduced their allocations to hedge 

funds or private equity. Other plan representatives also took steps to improve

investment terms, including more favorable fee structures and enhanced liquidity. 

However, some plan representatives and experts indicated that smaller plans 

would likely not be able to take some of these steps. 

The Department of Labor has provided some guidance to plans regarding 

investing in derivatives, but has not taken any steps specifically related to hedge 

fund and private equity investments. In recent years, however, other entities have 

addressed this issue. For example, in 2009, the President’s Working Group on 

Financial Markets issued best practices for hedge fund investors. Further, both 

GAO and a Department of Labor advisory body have recommended that the 

department publish guidance for plans that invest in such alternative assets. To 

date, it has not done so, in part because of a concern that the lack of uniformity 

among such investments could make development of useful guidance difficult. In 

2011, the Department of Labor advisory body specifically revisited the issue of 

pension plans’ investments in hedge funds and private equity, and a report is 

expected in early 2012.

View GAO-12-324. For more information, 

contact Charles Jeszeck at (202) 512-7215 or 

jeszeckc@gao.gov.
Page i GAO-12-324 Defined Benefit Pension Plans

Letter 1 

Background 4

Selected Pension Plans Reported Mixed Experiences with Hedge 

Funds and Private Equity Investments, and Some Faced 

Significant Losses and Other Challenges 8

Plans Continue to Invest in Hedge Funds and Private Equity, but 

Some Plan Sponsors Have Taken Steps to Address Challenges 18

Federal Entities and Others Have Developed Guidance Addressing 

Hedge Funds and Private Equity 30

Concluding Observations 33

Agency Comments 35

Appendix I Objectives, Scope, and Methodology 36

Appendix II GAO Contact and Staff Acknowledgments 43

Tables

Table 1: Recent Data from Hedge Fund, Private Equity, and S&P 

500 Indexes 9

Table 2: Performance of Hedge Fund and Private Equity 

Investments Compared to Selected Plans’ Expectations 10

Table 3: List of Pension Plans Interviewed 37

Table 4: Criteria Used in 2008 Selection of Plans for In-Depth 

Interviews 38

Table 5: Number and Size of Pension Plans Observed in Recent 

Surveys 41

Figures

Figure 1: Typical Private Equity Long-term Investment Profile 14

Figure 2: Share of Large DB Plans Investing in Hedge Funds and 

Private Equity from 2001 to 2010 19

Figure 3: Pension Plans with Investments in Hedge Funds and 

Private Equity by Size of Total Plan Assets in 2010 21

Figure 4: Comparison of Commingled and Separate Accounts 26

Contents
Page ii GAO-12-324 Defined Benefit Pension Plans

Abbreviations

Dodd-Frank Act Dodd-Frank Wall Street Reform and Consumer 

 Protection Act 

ERISA Employee Retirement Income Security Act 

ILPA Institutional Limited Partners Association 

IOPS International Organisation of Pension Supervisors 

Labor Department of Labor 

OECD Organisation for Economic Cooperation and 

 Development

SEC Securities and Exchange Commission

This is a work of the U.S. government and is not subject to copyright protection in the 

United States. The published product may be reproduced and distributed in its entirety 

without further permission from GAO. However, because this work may contain 

copyrighted images or other material, permission from the copyright holder may be 

necessary if you wish to reproduce this material separately.
Page 1 GAO-12-324 Defined Benefit Pension Plans

United States Government Accountability Office

Washington, DC 20548

February 16, 2012

The Honorable Robert E. Andrews

Ranking Member

Subcommittee on Health, Employment, Labor, 

 and Pensions

Committee on Education and the Workforce

House of Representatives

Dear Mr. Andrews:

Millions of Americans rely on defined benefit pension plans for their 

financial well-being in retirement. In order to pay promised retirement 

benefits when due and at an acceptable cost, employers must make 

adequate contributions to these funds, and plan fiduciaries must invest 

the fund balance in assets that yield an adequate rate of return over time.

Public and private sector pension plans have primarily invested in 

traditional investments such as stocks and bonds, but plans are 

increasingly investing in “alternative” investments such as hedge funds 

and private equity funds.

Generally, hedge funds and private equity funds are privately organized 

and managed funds that are available only to institutional investors or 

wealthy individuals. Historically, both have been managed in ways that 

exempt them from certain aspects of federal securities law and regulation 

that apply to other investment pools such as mutual funds. However, as a 

result of the Dodd-Frank Wall Street Reform and Consumer Protection 

Act (Dodd-Frank Act),1

Much has happened in the financial markets since GAO issued a report in 

2008 examining the extent to which pension plans invest in hedge funds 

most hedge fund and private equity managers will 

be required to register with the Securities and Exchange Commission 

(SEC) and comply with new aspects of federal securities law.

 

1

Pub. L. No. 111-203, 124 Stat. 1376 (2010).

 
 

Page 2 GAO-12-324 Defined Benefit Pension Plans

and private equity.2 The financial market events of the second half of 

2008 significantly affected hedge funds. According to a 2009 industry 

survey, most hedge fund strategies produced double-digit losses in 2008, 

and hedge funds saw approximately $70 billion in redemptions between 

June and November 2008.3 Nevertheless, many of these investments 

have rebounded, and a 2010 industry survey of institutional investors 

suggests that these investors continue to be committed to investing in 

hedge funds but with a shifting set of objectives and criteria.4

In order to assess the extent to which pension plans have realized 

desired benefits from investing in hedge funds and private equity, and 

actions they may have taken in response to recent experiences, 

particularly given ongoing market volatility, you asked us to examine the 

following questions:

Private 

equity investment values were also substantially lowered during this 

period and have similarly recovered along with values in the public 

equities market. However, given ongoing market volatility, concerns 

remain about how well such investments will meet the expectations of 

plan sponsors that have invested in them.

• What is known about the experiences of defined benefit pension plans 

with investments in hedge funds and private equity, including recent 

lessons learned?

• How have plan sponsors responded to lessons learned from recent 

experiences with such alternative investments?

 

2

This report, GAO, Defined Benefit Pension Plans: Guidance Needed to Better Inform 

Plans of the Challenges and Risks of Investing in Hedge Funds and Private Equity, 

GAO-08-692, (Washington, D.C.: Aug.14, 2008), was followed by other GAO documents 

reflecting more recent data in 2010 and 2011. These documents were Defined Benefit 

Pension Plans: Plans Face Valuation and Other Challenges When Investing in Hedge 

Funds and Private Equity, GAO-10-915T (Washington, D.C.: July 20, 2010) and Defined 

Benefit Pension Plans, Plans Face Challenges When Investing in Hedge Funds and 

Private Equity, GAO-11-901SP (Washington, D.C.: Aug. 31, 2011). 

3

Greenwich Associates and SEI Knowledge Partnership, Hedge Funds under the 

Microscope: Examining Institutional Commitment in Challenging Times (January 2009). 

4

Greenwich Associates and SEI Knowledge Partnership, Institutional Hedge Fund 

Investing Comes of Age: A New Perspective on the Road Ahead (June 2011).
 

Page 3 GAO-12-324 Defined Benefit Pension Plans

• What steps have federal agencies and other entities taken to help 

plan sponsors make and manage investments in such alternative 

assets, and what additional steps might be warranted?

To answer these questions, we reviewed relevant literature; analyzed 

data; interviewed relevant federal agencies and industry experts; 

conducted in-depth, follow-up interviews with pension plan sponsors 

contacted in the course of our prior related work; and surveyed a selected 

group of 20 plan consultants, academic experts, and other industry 

experts. Specifically, we conducted in-depth, follow-up interviews with 

representatives of 22 public and private sector defined benefit pension 

plans that were interviewed for our 2008 report examining the extent to 

which pension plans invest in hedge funds and private equity.5 We 

identified these plans in 2008 using data from the 2006 Pensions & 

Investments survey of the largest 200 pension plans and through our 

interviews with industry experts. Plan representatives’ responses from 

these interviews do not represent a statistically generalizeable sample of 

all pension plans. We interviewed officials of federal agencies, relevant 

national organizations, pension plan consulting firms, and other national 

experts. We conducted a survey of five open-ended questions with plan 

consultants, academic and industry experts, representatives of plan 

participants, and representatives of public and private plan sponsors. We 

obtained data on the national performance of hedge fund and private 

equity investments from private organizations, Cambridge Associates 

LLC and Hedge Fund Research, Inc. We obtained and analyzed survey 

data on the extent to which pension plan sponsors continue to invest in 

hedge funds and private equity from two private organizations, Greenwich 

Associates and Pensions & Investments. We conducted our work from 

February 2011 to February 2012 in accordance with generally accepted 

government auditing standards. Those standards require that we plan 

and perform the audit to obtain sufficient, appropriate evidence to provide 

a reasonable basis for our findings and conclusions based on our audit 

objectives. We believe that the evidence obtained provides a reasonable 

basis for our findings and conclusions based on our audit objectives. For 

more information on our objectives, scope, and methodology, see 

appendix I.

 

5

GAO-08-692. 
 

Page 4 GAO-12-324 Defined Benefit Pension Plans

Defined benefit pension plans are intended to pay retirement benefits that 

are generally based on an employee’s years of service and other factors. 

The financial condition of these plans—and hence their ability to pay 

retirement benefits when due—depends on adequate contributions from 

employers and sometimes employees, and prudent investments that yield 

an adequate rate of return over time. Poor investment choices can have 

serious implications for both the plan sponsor and, potentially, plan 

beneficiaries. Poor investment results may necessitate greater 

contributions by the plan sponsor, which could result in lower profits in the 

case of a private plan sponsor, or higher taxes in the case of a public 

plan. In some cases, the plan sponsor could opt to require greater 

participant contributions or reduce future retiree benefits. Plan sponsors 

generally try to maximize returns for an acceptable level of risk and, in 

doing so, may invest in various categories of asset classes, which for 

many years have consisted mainly of stocks and bonds. Plan sponsors 

may also invest in other asset classes or trading strategies, sometimes 

referred to as alternative investments—which can include a wide range of 

assets such as hedge funds, private equity, real estate, and commodities.

Plans may make such investments in an effort to diversify their portfolios, 

achieve higher returns or for other reasons. In recent years, hedge funds 

and private equity have been two of the most common alternative assets 

held by institutional investors such as public and private pension plans.

Although there is no universally accepted definition of hedge funds, the 

term is commonly used to describe pooled investment vehicles that are 

privately organized and administered by professional managers who often 

engage in active trading of various types of securities, commodity futures, 

options contracts, and other investment vehicles.6

 

6

In both the hedge fund and private equity industries, the entity that is responsible for 

management of the fund is commonly referred to as the general partner, and an investor 

in the fund is commonly referred to as a limited partner. In this report, except where other 

terminology is appropriate, we refer the general partner as the fund manager, and the 

limited partners as co-investors. 

Hedge funds can also 

hold relatively illiquid and hard-to-value investments such as real estate 

or shares in private equity funds. Although hedge funds have a reputation 

of being risky investments that seek exceptional returns, this was not their 

original purpose, and is not true of all hedge funds today. Established in 

the 1940s, one of the first hedge funds invested in equities and used 

leverage and short selling to protect, or “hedge” the portfolio from its 

Background 
 

Page 5 GAO-12-324 Defined Benefit Pension Plans

exposure to the stock market.7

Likewise, there is no commonly accepted definition of private equity 

funds, but such funds are generally privately managed pools of capital 

that invest in companies, many of which are not listed on a stock 

exchange. Unlike many hedge funds, private equity funds typically make 

longer-term investments in private companies. Private equity funds also 

seek to obtain financial returns through long-term appreciation based on 

active management. Strategies of private equity funds vary, but most 

funds target either venture capital or buy-out opportunities. Venture 

capital funds invest in young companies that often are developing a new 

product or technology. Private equity fund managers may provide 

expertise to a fledgling company to help it become suitable for an initial

public offering. Buy-out funds generally invest in larger established 

companies in order to add value, in part, by increasing efficiencies and, in 

some cases, consolidating resources by merging complementary 

businesses or technologies. For both venture capital and buy-out 

strategies, investors hope to profit when the company is eventually sold, 

either when offered to the public or when sold to another investor or 

company. Unlike stocks and bonds, which are traded and priced in public 

markets, plans have limited information on the value of private equity 

investments until the underlying holdings are sold.

Over time, hedge funds diversified their 

investment portfolios and engaged in a wider variety of investments 

strategies. As GAO reported in 2008, defined benefit pension plans have 

invested in hedge funds for a number of reasons, including the desire for 

investment returns that exceed the returns available in the stock market 

or obtaining steadier, less volatile returns.

Traditionally, hedge funds and private equity funds and their managers 

have been exempt from certain registration, disclosure and other 

requirements under various federal securities laws. The presumption is 

that investors in such vehicles have the sophistication to understand the 

risks involved in investing in them and the resources to absorb any losses 

they may suffer. However, as a result of the Dodd-Frank Act, the 

managers of such investment vehicles will be regulated in ways that they 

 

7

Leverage involves the use of borrowed money or other techniques to potentially increase 

an investments’ value or return without increasing the capital invested. A short sale is the 

sale of a security that the seller does not own or a sale that is consummated by the 

delivery of a security borrowed by, or for, the account of the seller. Short selling is 

generally used to profit by the decline in the price of a security. 
 

Page 6 GAO-12-324 Defined Benefit Pension Plans

have not been previously.8 For example, hedge fund and private equity 

managers will generally now be required to register with the SEC, 

establish a specific regulatory compliance program, and comply with 

various record-keeping requirements.

9

Private sector pension plan investment decisions must comply with 

provisions of Employee Retirement Income Security Act (ERISA), which 

set forth fiduciary standards based on the principle of a prudent standard 

of care. Under ERISA, plan sponsors and other fiduciaries must (1) act 

solely in the interest of the plan participants and beneficiaries and in 

accordance with plan documents; (2) invest with the care, skill, and 

diligence of a prudent person familiar with such matters; and (3) diversify 

plan investments to minimize the risk of large losses. Under ERISA, the 

prudence of any individual investment is considered in the context of the 

total plan portfolio, rather than in isolation.

 While these fund managers must 

now register with the SEC, the funds they manage will remain 

unregistered. Unlike other investment funds—such as mutual funds—that 

register with the SEC, hedge funds and private equity funds are thus not 

subject to certain requirements, such as limitations on leverage and 

minimum requirements relating to corporate governance.

10

 

8

15 U.S.C. § 80b-20 note, section 401-419 of the Dodd-Frank Wall Street Reform and 

Consumer Protection Act (Pub. L. No. 111-203, 124 Stat. 1376 (2010)).

Public sector plans, such as 

those at the state, county, and municipal levels, are not subject to 

funding, vesting, and most other requirements applicable to private sector 

defined benefit pension plans under ERISA, but must follow requirements 

established for them under applicable state law. Many states have 

enacted standards comparable to those of ERISA.

9

Some hedge fund and private equity managers will remain exempt under the new law. 

For example, certain fund managers with less than $150 million in assets under 

management will not be required to register with the SEC. Exemption for Advisers to 

Venture Capital Funds with Less than $150 Million in Assets Under Management, and 

Foreign Private Advisers No. 57-37-10, 76 Fed. Reg. 39646 ( 2011).

10ERISA’s “prudent man” standard with respect to investment duties is treated under 29 

C.F.R. § 2550.404a-1(b). In general, it provides that that the prudent man standard is 

satisfied if the fiduciary has given appropriate consideration, among other facts and 

circumstances, to the following factors (1) the composition of the plan portfolio with regard 

to diversification of risk; (2) the volatility of the plan investment portfolio with regard to 

general movements of investment prices; (3) the liquidity of the plan investment portfolio 

relative to the funding objectives of the plan; (4) the projected return of the plan 

investment portfolio relative to the funding objectives of the plan; and (5) the prevailing 

and projected economic conditions of the entities in which the plan has invested and 

proposes to invest. 
 

Page 7 GAO-12-324 Defined Benefit Pension Plans

In 2008, we reported on plan investments in hedge funds and private 

equity, including a discussion of the benefits that plan fiduciaries seek 

and challenges they face in doing so. We concluded that, because these 

investments require a degree of fiduciary effort well beyond that required 

by more traditional investments, doing so can be a difficult challenge, 

especially for smaller plans. Such plans may not have the expertise or 

financial resources to be fully aware of these challenges, or have the 

ability to address them through negotiation, due diligence, and

monitoring. Further, we noted that, while plans are responsible for making 

prudent choices when investing in any asset, the Department of Labor 

(Labor) also has a role in helping to ensure that pension plan sponsors 

fulfill their fiduciary duties in managing pension plans that are subject to 

ERISA. This can include educating employers and service providers 

about their fiduciary responsibilities under ERISA. In light of these duties, 

and the risks and challenges of investing in hedge funds and private 

equity, we recommended that the Secretary of Labor issue guidance 

specifically designed for qualified plans under ERISA. We specifically 

called for guidance that would (1) outline the unique challenges of 

investing in hedge funds and private equity; (2) describe steps that plans 

should take to address these challenges and help meet ERISA 

requirements; and (3) explain the implications of these challenges and 

steps for smaller plans. To date, Labor has not implemented this 

recommendation. In responding to GAO’s 2008 recommendation, Labor 

noted that while it would consider the recommendation, the lack of 

uniformity among hedge funds and private equity funds could make 

development of comprehensive and useful guidance difficult.
 

Page 8 GAO-12-324 Defined Benefit Pension Plans

Hedge fund and private equity indexes show that these investments were 

significantly affected by the financial market turbulence of recent years, 

and plans and experts we contacted indicated that pension plan 

investments were not insulated from losses. According to a composite 

hedge fund index, in the midst of the financial crisis, hedge funds 

produced quarterly losses as great as 16 percent in the last quarter of 

2008.11 Similarly, a private equity index measured losses throughout most 

of 2008, with losses of a little more than 15 percent in the last quarter.12

 

11Hedge Fund Research, Inc., HFRI Fund Weighted Composite Index. According to this 

index, hedge funds produced quarterly losses in 3 of the 4 quarters in 2008. 

In 

comparison, the stock market, as measured by the Standard and Poor’s 

500 index, declined in value by close to 40 percent in 2008 (see table 1 

for a comparison of recent data from various indexes). Our in-depth 

discussions with plan representatives were largely consistent with these 

national trends. Although not all plan sponsor representatives we 

interviewed reported specific performance data, a number of plan 

representatives disclosed peak annual hedge fund losses in 2008 or 2009 

ranging from about 12 percent to about 25 percent. Pension plan 

representatives we interviewed generally reported more favorable 

performance for private equity. Although a few plan representatives 

reported private equity returns that were somewhat lower than in previous 

12Cambridge Associates LLC, U.S. Private Equity Index, June 30, 2011. The index is an 

end-to-end calculation based on data compiled from 899 U.S. private equity funds 

(buyout, growth equity, private equity energy, and mezzanine funds), including fully 

liquidated partnerships, formed between 1986 and 2011.

Selected Pension 

Plans Reported Mixed 

Experiences with 

Hedge Funds and 

Private Equity 

Investments, and 

Some Faced 

Significant Losses and 

Other Challenges

Hedge Fund and Private 

Equity Investments Were 

Affected by the Financial 

Crisis, but Most Selected 

Plans Indicated These 

Investments Met 

Expectations 
 

Page 9 GAO-12-324 Defined Benefit Pension Plans

years, one plan reported a close to 20 percent loss for their private equity 

portfolio in 2009.

Table 1: Recent Data from Hedge Fund, Private Equity, and S&P 500 Indexes

Historical performance (in percentages)

Index 1 year (2011) 3 year (2009-2011) 5 year (2007-2011)

HFRI Fund Weighted 

Composite (5.02) 7.9 2.27

Cambridge Private 

Equity 13.76 7.32 8.11

S&P 500 2.11 14.11 (0.25)

Sources: Hedge Fund Research, Inc., HFRI Fund Weighted Composite Index; Cambridge Associates LLC, U.S. Private Equity Index; 

and S&P 500 Index.

Note: Numbers in parentheses are negative. Hedge Fund Research, Inc., HFRI Fund Weighted 

Composite Index and S&P 500 Index data are as of December 31, 2011. Cambridge Associates LLC, 

U.S. Private Equity Index data are as of September 30, 2011.

Despite experiencing some significant losses during the financial crisis, 

representatives of selected plan sponsors we contacted generally told us 

that both their hedge fund and private equity investments met their 

expectations over the last 5 years given their reasons for investing.

Most of the 22 pension plan representatives we contacted indicated that 

hedge fund investments met their expectations given their reasons for 

investing. In 2008, we reported that many plans had invested in hedge 

funds in response to prior significant stock market losses, and because 

they were seeking specific benefits such as achieving (1) lower volatility; 

(2) a more diversified portfolio by investing in a vehicle that would not be 

correlated with other asset classes in the portfolio; and (3) returns greater 

than those expected in the stock market. Given these reasons for 

investing in hedge funds, most of the 22 plan representatives we 

interviewed for this report said that these investments met plan 

expectations (see table 2 for an overview of the responses).

Hedge Funds
 

Page 10 GAO-12-324 Defined Benefit Pension Plans

Table 2: Performance of Hedge Fund and Private Equity Investments Compared to

Selected Plans’ Expectations 

Number of plans

Plan response Hedge fund Private equity 

Met expectations 12 20

Did not meet expectations 5 0 

Mixed 1 2 

Total 18 22

Source: GAO analysis of interview responses.

Note: Four plans we interviewed had not invested in hedge funds when we interviewed them for our 

2008 report and therefore could not provide an assessment.

Representatives of several plans stressed the moderating impact of 

hedge fund investments by noting their ability to provide less price 

volatility than other investments. One plan representative observed, that 

even with hedge fund fees, their losses of 14 percent were still preferable 

to stock market losses of 40 percent. Representatives from another plan 

explained that, although hedge fund performance more closely paralleled 

the stock market during the period than desired, there was generally no 

safe haven and that hedge fund investments have generally performed 

well. A few plan representatives noted that hedge funds delivered lower 

volatility than other investments.13

 

13Volatility refers to the propensity of the price of a security to move up or down over time; 

if the price of a security moves up or down rapidly over a short period of time, it is 

considered to have higher volatility. Stocks offer relatively high expected long-term returns 

at the risk of considerable volatility, that is, the likelihood of significant short-term losses or 

gains. Plan sponsor representatives may invest in hedge funds that employ a specific 

investment strategy to meet plan goals, such as lower volatility. Because some hedge 

fund strategies are not solely dependent on equity and fixed income markets for their 

returns, they may produce significantly less volatility. 

 Representatives from one plan were 

particularly satisfied with how the plan’s hedge fund investments helped 

limit overall portfolio risks, noting that although returns were below 

benchmarks, the hedge funds provided much less volatility than the plan’s 

publicly traded stock holdings. Similarly, representatives from another 

plan noted that, since 2002, hedge funds have provided adequate 

returns, but with much less volatility than publicly traded stocks. 

Additionally, representatives from one plan, who had not invested in 

hedge funds when we interviewed them for our 2008 report, have recently 

begun implementing a relatively small hedge fund allocation that they 
 

Page 11 GAO-12-324 Defined Benefit Pension Plans

believe will complement the rest of their portfolio and provide greater 

diversification benefits, including reducing overall portfolio volatility.

Some plan sponsor representatives stressed the positive long-term 

performance of their hedge fund investments, despite intervals of poor 

performance. While these plan representatives would have preferred 

better hedge fund performance during the 2008-2009 financial crisis, 

hedge funds have nonetheless filled an important long-term role in these 

plans’ portfolios. Representatives from one plan noted hedge fund losses 

of about 12 percent during 2009 but indicated that overall since 2004 

these investments have performed well. Representatives from one plan 

told us that while they were disappointed by the size of hedge fund losses 

in 2008-2009, these investments have generally beaten long-term 

benchmarks and have recovered since the crisis. Moreover, they noted 

that compounded over the last 15 years, the plan’s hedge fund 

investment returns are about twice those of the stock market. These plan 

representatives also emphasized the importance of hedge funds, as well 

as other alternative investments, to long-term investment returns by 

noting that investing solely in fixed income investments would not have 

sustained the plan’s funding needs, particularly given that the plan 

sponsor had not made plan contributions in over 20 years.

In contrast, a number of plan sponsor representatives and experts noted 

that hedge funds did not perform as expected. Representatives from one 

plan explained that they expected these investments to provide an 

absolute return—positive return regardless of the conditions in the stock 

market—in exchange for muted returns in robust markets. Another plan 

representative noted that while he understood these “absolute return” 

funds may not always generate positive returns in all market 

environments, he expected their hedge funds to deliver better than the 

more than 20 percent losses they experienced from 2008-2009. Similarly, 

a representative from one plan expected hedge fund investments to 

perform more independently of stock market trends and was surprised 

and disappointed by the magnitude of the negative returns. This 

representative told us that for every dollar of loss in the 2008-2009 stock 

market, their hedge fund investments lost two-thirds of a dollar. A few 

experts noted that pension plan hedge fund investments were more 

correlated than expected with the public markets during the financial 

crisis, resulting in what one expert referred to as exacerbated losses. For 

example, one expert noted that some plan representatives may have 
 

Page 12 GAO-12-324 Defined Benefit Pension Plans

overpaid for mediocre returns when they paid hedge fund performance 

and management fees to obtain returns similar to the stock market.14

Further, one specific hedge fund strategy performed poorly. Several plans 

singled out the so-called “portable alpha” strategy, which typically 

employs hedge funds in order to generate returns that exceed common 

market benchmarks.15

Some plan representatives and one surveyed expert singled out the 

impact of fees on net performance. One expert cited the extra layer of 

fees charged by funds of funds managers, asserting that these fees 

substantially lowered plans’ net returns.

A representative of one plan told us that the plan’s 

portable alpha program was hugely disappointing and consequently being 

dismantled. Specifically, in 2008-2009, a portion of the investment lost 

considerable value when the stock market fell by more than 30 percent.

16

The experience of plans with private equity investments should be 

considered in the context of the long-term nature of these investments, 

which require lengthy financial commitments and delayed financial returns 

(see fig. 1). Given the long-term nature of private equity investments, 

Similarly, a plan representative 

we spoke with found hedge fund fees at the individual fund level to be 

eroding investment returns. This representative noted while the plan’s 

hedge fund gross return has been outperforming the rest of the portfolio, 

the investment has underperformed after fees have been deducted for the 

last few years. For this reason, the plan is consciously lowering its 

investment allocation in hedge funds. A representative from another plan 

noted dissatisfaction with the plan’s hedge fund of funds investment as 

one of the reasons that the plan had chosen not to reinvest and was 

considering firing the fund manager.

 

14Whereas mutual fund managers reportedly charge a fee of about 1 percent of assets 

under management, hedge fund managers often charge a flat fee of 2 percent of total 

assets under management, plus a performance fee, of about 20 percent of the fund’s 

profits. While this fee structure may vary slightly among funds, it has been a common 

structure in both the hedge fund and private equity industries. 

15The portable alpha strategy is designed to deliver better returns than traditional 

benchmarks. Typically, the strategy involves using derivatives to replicate benchmark 

returns (beta), which leaves excess cash that can be invested in hedge fund strategies to 

obtain returns above the stock market (alpha).

16Funds of funds’ managers charge fees above those of the hedge fund manager. For 

example, funds of funds managers may charge a 1 percent flat fee and a performance fee 

of between 5 and 10 percent of profits—on top of the substantial fees that the fund of 

funds pays to the underlying hedge funds.

Private Equity
 

Page 13 GAO-12-324 Defined Benefit Pension Plans

nearly all of the 22 pension plan representatives we interviewed were 

generally satisfied with their private equity investments over the last 5 

years. Based on findings from our 2008 report, plans we interviewed 

generally invested in private equity to attain higher returns than the stock 

market offered, in exchange for greater risk. Given these reasons for 

investing in private equity, 20 of 22 plan representatives reported that the 

plan’s private equity investments met plan expectations. Further, nearly 

half of plan representatives indicated that their plans’ private equity 

investments outperformed public equities over the last 5 years. For at 

least one plan, private equity was the highest performing asset class. In 

particular, several plan representatives and surveyed experts noted that 

opportunistic investments, those investments that take advantage of 

underperformance during market cycles, such as distressed debt, 

performed relatively well during the last 5 years.17

 

17A few plan officials indicated that opportunistic private equity investments such as 

distressed debt are shorter in duration than traditional private equity investments, such as 

leveraged buy-outs and venture capital. For example, private equity distressed debt 

investment involves the fund purchasing severely discounted corporate bonds of 

companies that have filed for bankruptcy or appear likely to do so in order to become a 

major creditor. The fund is then positioned to control the company’s liquidation or 

reorganization. In the event of a bankruptcy, as a major creditor, the fund will likely 

recover all their money, if not a profit, as part of the liquidation of assets. Alternatively, in a 

typically more desirable outcome, the company will reorganize and come out of 

bankruptcy, and the fund will forgive the company’s debt obligation in exchange for 

enough equity to compensate them. 

Representatives from 

at least one plan said they were disappointed to have had insufficient 

capital available to invest more heavily in some of these opportunities. 

Like many of the plan representatives we interviewed, experts we 

surveyed largely found private equity investment performance for the 

period to be positive.
 

Page 14 GAO-12-324 Defined Benefit Pension Plans

Figure 1: Typical Private Equity Long-term Investment Profile

Note: This information is most relevant to more long-term private equity investments, such as 

leveraged buy-outs. Other types of private equity investment, such as distressed debt, may have a 

shorter financial commitment.

Although plan representatives we interviewed almost unanimously 

reported favorable results regarding private equity, this has not 

necessarily been true of all plans over the last 5 years. As we reported in 

2008, compared with other asset classes, performance varied widely 

among private equity funds. For this reason, plan representatives 
 

Page 15 GAO-12-324 Defined Benefit Pension Plans

emphasized the importance of investing in the top funds, some noting that 

they would not invest in private equity unless they could invest in funds 

considered to be in the top quartile. Three of the experts we surveyed in 

2011 also noted varying performance among private equity funds. One 

expert noted a wide dispersion among the performance of private equity 

funds, and that this dispersion likely is reflective of the broad experiences 

of pension plans over time. Similarly, two other experts cited evidence 

that, over the long-term, broad private equity fund returns did not 

outperform the stock market, and one of these experts reported that lower 

performance may be attributable to the typically riskier equities held in 

these investments. A representative from one plan, for example, 

remarked that the plan’s venture capital investments did not perform well. 

In this particular case involving the biotech industry, the representative 

noted that this was less a direct result of the financial crisis and more a 

function of the decline in this industry as a whole. Representatives from 

one large plan told us that venture capital investment performance had 

been problematic for them in the last 10 years. Similarly, we found that a 

number of plans we interviewed had lowered or eliminated their venture 

capital investment in recent years.

Pension plan representatives we contacted experienced some challenges 

in hedge fund and private equity investing beyond those of more 

traditional investing, including limited liquidity and transparency, and the 

negative impact of the actions of other investors in the fund—sometimes 

referred to as co-investors.

A number of plan representatives we interviewed experienced challenges 

with investment liquidity—a plan’s limited ability to redeem investment 

shares on demand—in order to meet plan obligations. Although hedge 

funds typically have limitations on the timing and magnitude of investor 

redemptions, a few plan representatives we contacted were surprised and 

financially harmed by “discretionary gates”—limitations on redemptions 

Some Selected Plans 

Faced Specific Challenges 

with Hedge Fund and 

Private Equity Investments 

in Recent Years

Liquidity Limitations
 

Page 16 GAO-12-324 Defined Benefit Pension Plans

imposed at a fund manager’s discretion.18 For example, a representative 

from one large plan told us that some hedge fund managers imposed 

discretionary gates based on what was best for the fund’s business model 

and not what was in the best interests of the investors. This 

representative was concerned that hedge fund managers lacked 

incentives to seek returns and were focused on gathering assets, locking 

them up, and collecting the fees. Public documents from this plan noted 

the possibility that a hedge fund manager can earn tens of millions of 

dollars in performance fees in 1 year and then experience sizable losses 

in another, resulting in only a minimal capital gain or even net loss for the 

investor, but sizable profits for the fund manager at the end of the 

partnership.19

Some plans also faced challenges meeting requests for committed 

capital—money they have committed to the fund manager for 

Also, because plan representatives from at least one plan 

intended to use hedge fund redemptions to pay for plan obligations, 

unexpected discretionary gates forced them to instead sell public equities 

at a significant loss. Specifically, representatives from one plan told us 

that when the market was down more than 30 percent, they were unable 

to access their hedge fund investments due to gates imposed by the fund 

manager after other co-investors began liquidating their holdings. 

Representatives from this plan told us they were then compelled to sell 

public equities at a price well below their assessment of the equities’ 

intrinsic value, in order to meet plan obligations, including benefit 

payments to plan participants.

 

18As we reported in 2008, hedge funds offer investors relatively limited liquidity, that is, 

investors may not be able to redeem a hedge fund investment on demand because of a 

hedge fund’s redemption policy. Hedge funds often require an initial “lockup” of a year or 

more, during which an investor cannot cash out of the hedge fund. After the initial lockup 

period, hedge funds offer occasional liquidity, sometimes with a prenotification 

requirement. Occasional liquidity may be limited by a fund manager’s right to limit the 

amount of redemptions in a stated period. Limitations on redemptions, including 

discretionary gates, can be important to hedge funds because sudden liquidations could 

disrupt a carefully calibrated investment strategy and because some of the hedge fund’s 

underlying assets may themselves be illiquid. 

19The effect of such performance fee structures can be moderated by “clawback” 

provisions—which provide investors the right to reclaim a portion of a fund manager’s 

performance fee based on significant losses from later investments in the fund’s 

portfolio—in the investment contract. Similarly, “high water mark” provisions can 

moderate the effect of such performance fee structures by ensuring that investors will not 

pay a performance fee unless the value of the investment passes a previous peak value of 

the fund shares.
 

Page 17 GAO-12-324 Defined Benefit Pension Plans

investment—from private equity fund managers. A few plan 

representatives relied on a “self funding” private equity program in which 

private equity investment proceeds are sufficient to pay for a portion or all 

of the program’s committed capital. However, in some cases, the severe 

market decline during this period limited investment proceeds. 

Consequently, a few plans had to look for liquidity in their portfolio in 

order to fund capital commitments. While the plan representatives we 

spoke with were able to meet these financial commitments, a number of 

plans said they limited new private equity investment during this period.

A small number of plans we interviewed noted challenges with hedge 

fund transparency during this period. One plan representative we 

interviewed invested in a fund of hedge funds20

A few of the plan representatives noted challenges related to coinvestors’ actions. Under commingled investments arrangements, each 

with very limited 

transparency, but that promised access to certain high-quality hedge 

funds. As transparency improved after the 2008-2009 financial crisis, the 

plan sponsor learned that the various funds of funds had considerable 

overlapping investments, which likely amplified the funds’ of funds 

negative performance. A few plan representatives were unpleasantly 

surprised by the extent to which their plans’ hedge funds were invested in 

“side pockets”—separate side accounts holding illiquid investments, such 

as private equity or real estate. For example, representatives from one 

plan told us they were not fully aware of the way some of their funds were 

invested in these side pockets and consequently were surprised by the 

illiquidity of the investment. A representative from another plan was 

similarly surprised by how embedded some of their hedge fund 

investments were with side pockets, which proved problematic when the 

plan looked to these hedge fund investments for liquidity during the 

financial crisis and it was not available. Representatives of another plan 

expressed an aversion to such side pocket investments and preferred to 

invest in private equity directly rather than doing so unbeknownst to them 

through a hedge fund manager.

 

20Individuals and institutions may also invest in hedge funds through funds of hedge 

funds, which are investment funds that buy shares of multiple underlying hedge funds. 

Fund of funds managers invest in other hedge funds rather than trade directly in the 

financial markets and thus offer investors broader exposure to different hedge fund 

managers and strategies. Like hedge funds, funds of funds may be exempt from various 

aspects of federal securities laws and regulations.

Limited Transparency

Negative Impact of the Actions 

of Co-Investors
 

Page 18 GAO-12-324 Defined Benefit Pension Plans

investor owns a certain number of shares in a fund. During the recent 

financial crisis, the significance of these arrangements became 

particularly challenging for a few plan representatives. For example, 

representatives from one plan reported that while they were able to meet 

all of their private equity capital calls—a request from the fund manager 

for the investors to provide a portion of the money they have committed to 

investing—they were concerned about the ability of other co-investors to 

do so. In response to these concerns, the representatives felt compelled 

to take the time to call each of their fund managers to confirm the ability 

of all the investors to meet their financial commitments. Representatives 

of another plan noted that the actions of co-investors can impact an 

investment strategy, which may ultimately impact returns. For example, 

representatives of this plan said they had invested with a private equity 

fund manager who was implementing a strategy involving an investment 

in 10, $1 billion companies. However, because not all investors could 

meet their financial commitments, the fund manager had to restructure 

the investment strategy. The plan representatives were troubled by the 

strategy changes—involving investments in different companies—the 

fund manager had to make as a result.

At least one plan representative also indicated that an onslaught of hedge 

fund redemptions by other co-investors damaged their investments. For 

example, representatives of one plan told us that many of their coinvestors, alarmed by large losses during the financial crisis, moved 

quickly to cash out investments. Because co-investor redemptions led to 

further fund losses, plan representatives felt it was necessary to cash out 

as well. However, they were unable to do so, because the fund manager 

had imposed a discretionary gate to prevent further losses.

Available data reveal that plan investments in hedge funds and private 

equity have continued to increase, and our contacts with 22 public and 

private defined benefit (DB) plan sponsors also reveal a continued 

commitment to these investment vehicles. Nonetheless, some plans have 

reduced their allocations or made significant changes to their strategic 

approach as a result of experiences in recent years. In addition, plan 

representatives we contacted took significant steps to improve the terms 

of their investments, including negotiating lower fees or more 

advantageous fee terms, and obtaining greater liquidity or transparency.

Not all plans may be able to make such improvements, however.

Plans Continue to 

Invest in Hedge Funds 

and Private Equity, 

but Some Plan 

Sponsors Have Taken 

Steps to Address 

Challenges 
 

Page 19 GAO-12-324 Defined Benefit Pension Plans

Available data and discussions with plan representatives indicate that DB 

plans have continued to invest in hedge funds and private equity in recent 

years. The percentage of large plans investing in both hedge fund and 

private equity has increased since the onset of the 2008 financial crisis.

According to a Pensions & Investments survey, the percentage of large 

plans (as measured by total plan assets) investing in hedge funds grew 

from 47 percent in 2007 to 60 percent in 2010 (see fig. 2). Over the same 

time period, the percentage of large plans that invested in private equity 

also grew—from 80 percent to 92 percent. For both hedge funds and 

private equity, as figure 2 shows, these trends are a continuation of a 

decade-long upward trend. Data from the same survey reveal that 

investments in hedge funds and private equity typically constitute a small 

share of plan assets. The average allocation of portfolio assets to hedge 

funds among plans with such investments was a little over 5 percent in 

2010. Similarly, among plans with investments in private equity, the 

average allocation of portfolio assets was a little over 9 percent.

Figure 2: Share of Large DB Plans Investing in Hedge Funds and Private Equity 

from 2001 to 2010

Note: These data represent plans with $1 billion or more in total assets.

Plans Have Continued to 

Invest in Hedge Funds and 

Private Equity
 

Page 20 GAO-12-324 Defined Benefit Pension Plans

We reported in 2008 that available survey data showed larger plans were 

more likely to invest in hedge funds and private equity than midsize plans 

and, according to a survey by Greenwich Associates, that seemed to be 

the case in 2010 as well. The survey found that 22 percent of midsize 

plans—those with $250 million to $500 million in total assets—were 

invested in hedge funds compared with 40 percent of the largest plans—

those with over $5 billion in total assets (see fig. 3). Survey data on plans 

with less than $200 million in assets are unavailable, so the extent to 

which these smaller plans invest in hedge funds and private equity is 

unclear.21

 

21In addition, Pyramis Global Advisors conducted a survey of plans with $200 million or 

more in total assets, but we found analysis of the Pensions & Investments and Greenwich 

Associates surveys sufficient for our purposes. See GAO-08-962 for analysis of the 

Pyramis Global Advisors survey data. According to Labor estimates, individual private DB 

plans with less than $200 million in total assets comprised about 15 percent of the total 

assets of all private DB plans in 2005. These small plans also comprised of about 97 

percent of all DB plans in 2005. 
 

Page 21 GAO-12-324 Defined Benefit Pension Plans

Figure 3: Pension Plans with Investments in Hedge Funds and Private Equity by 

Size of Total Plan Assets in 2010

Note: The figure above includes public and corporate plans and does not include investments of 

collectively bargained plans.

Comments made to us by representatives of selected plan sponsors 

generally paralleled these national data. Of the 18 plans participating in 

our review that had invested in hedge funds, 17 told us they had either 

maintained or increased their allocations since our original contact in 

2007 or 2008. For example, one public plan that already had invested a 

substantial percentage of its assets in hedge funds increased its 

investments by about another 10 percent of the total portfolio.

Representatives of this plan explained that hedge fund investments, while 

not immune to stock market declines, had nonetheless performed much 

better than stocks during the financial crisis. Similarly, of the 22 plans 

participating in our review that had invested in private equity at the time of 

our original contact in 2007-2008, 19 told us that they had either 

maintained or increased their target allocation. Each of the 10 plans that 

had increased their allocations also cited positive performance returns.

For example, one plan representative explained that the allocation to 

private equity had increased even though the overall allocation to publicly 
 

Page 22 GAO-12-324 Defined Benefit Pension Plans

traded stocks has decreased. The representative explained that the plan 

was lowering its allocation to stocks as part of a broad risk reduction 

strategy, and that the additional return expected from private equity would 

therefore be essential. As the representative explained, this change was 

made with the belief that the increase in private equity will produce 

relatively high risk-adjusted returns and will therefore compensate for the 

lower expected yield resulting from the shift out of publicly traded stocks 

to bonds.

Experiences of recent years have led most plans we contacted to make 

significant changes to their hedge fund or private equity strategies, and in 

three cases, reductions in the overall allocation to hedge funds or private 

equity. For example, representatives of the one plan participating in our 

review that had reduced its overall allocations to hedge funds said that 

the plan’s poor experience with hedge funds was tied to illiquidity. These 

representatives explained that they had expected that their hedge fund 

investments would not be difficult to cash in when they needed to pay 

obligations, but they were prevented from doing so by discretionary gates 

imposed by the fund manager. As a result, the plan was forced to sell 

stocks during the crisis when values were depressed, resulting in 

significant losses.

Several plans also discontinued or reduced the use of certain hedge fund 

strategies. For example, representatives of three plans told us that they 

had discontinued so-called “portable alpha” strategies, which commonly 

use hedge funds to help achieve returns that exceed those of the public 

equities market. According to industry press, this technique largely fell out 

of favor as a result of substantial investment losses during the 2008-2009 

financial crisis. However, plan representatives indicated that 

disenchantment with the portable alpha technique did not necessarily 

mean abandonment of hedge funds generally. For example, after one of 

these three plans discontinued the portable alpha strategy, it opted to 

retain the hedge fund portion of the portable alpha investment.22

 

22Portable alpha strategies can employ both hedge funds and other investment 

techniques in an effort to obtain returns above those of traditional benchmarks, such as 

the S&P 500.

 Several 

other plans indicated that they invested in less aggressive hedge fund 

strategies. For example, a representative of one plan explained that the 

plan had shifted from hedge funds designed to deliver investment returns 

Most Plans Have Modified 

Investment Strategies in 

Recent Years

Changes to Hedge Fund 

Strategies 
 

Page 23 GAO-12-324 Defined Benefit Pension Plans

that exceed the overall stock market to strategies that will deliver returns 

comparable to the stock market but with less risk.

In contrast to the general trend toward greater investments in hedge 

funds, some plans eliminated or substantially reduced their use of funds 

of hedge funds. Representatives of one plan explained that this step was 

part of a planned evolution—the plan had invested in funds of funds as a 

first step, and planned on using its relationships with funds of funds 

managers to develop the expertise to make direct hedge fund 

investments. By 2011, this plan had accomplished that objective, and 80 

percent of its hedge fund investments were direct hedge fund 

investments. Another plan, however, discontinued funds of funds 

investments, concluding that funds of funds added an unnecessary layer 

of fees, offered the plan little opportunity to influence fees of underlying 

hedge funds, limited the plan’s ability to conduct manager due diligence, 

and led to some overlapping investments in underlying individual hedge 

funds. A representative of this plan told us that one of the funds of funds 

had emphasized its unique access to top tier hedge funds, and the plan 

sponsor later learned that some of its other funds of funds were invested 

in the same vehicle, diminishing the diversification benefits of the fund of 

funds. However, funds of funds may be necessary for smaller pension 

plans and plans that lack well-developed internal investment and risk 

management that wish to invest in alternatives such as hedge funds and 

private equity.

Several plans indicated that they have adjusted their private equity 

strategies in recent years. For example, representatives of several plans 

noted that as a result of the experiences during the financial crisis, they 

preferred investing in private equity buyout funds that rely more on the 

implementation of operational improvements in portfolio companies, 

rather than funds that rely on so-called financial engineering—using 

leveraging techniques to enhance the value of the stock. One plan 

representative explained that many private equity firms using financial 

engineering techniques had suffered severe losses during the financial 

crisis. As a result, this representative said the plan now prefers private 

equity funds that add value to portfolio companies through means such as 

better control of costs, improved marketing, and a more efficient 

distribution chain. Also, because of the diminished returns of venture 

capital funds in recent years, representatives of several plans said they

have reduced investments in such funds. Finally, several of the plans we 

contacted had made relatively short term, opportunistic investments in 

distressed debt as a result of the financial crisis. One plan representative 

explained that the financial crisis gave rise to this opportunity because 

Changes to Private Equity 

Strategies 
 

Page 24 GAO-12-324 Defined Benefit Pension Plans

distressed debt oriented funds tend to perform well in bad economic times 

as the universe of troubled companies grows and other investors become 

more risk-averse.

Steps plan sponsors have taken to obtain more advantageous terms 

when investing in hedge funds and private equity include lower fees, 

greater control and transparency, and changed liquidity terms.

More advantageous fee terms. A little more than half of the plans included 

in our review have taken steps to obtain more advantageous fee terms for 

both hedge fund and private equity investments. For example, as part of a 

broad policy change regarding its relationship with hedge fund managers, 

one large public plan has determined that it will seek to avoid investing in 

hedge funds that insist on the traditional “2 and 20” fee structure, under 

which investors pay an annual management fee of 2 percent of assets 

under management, and a performance fee of 20 percent of profits.

Instead, the plan will seek to limit both management and performance 

fees and ensure that performance fees are paid not on an annual basis, 

but for more sustained, long-term performance. Representatives of 

another plan explained that they had obtained lower fees in exchange for 

trade-offs related to other aspects of investment terms. Specifically, for 

some hedge fund investments, this plan pays a flat fee of 1.5 percent of 

assets under management, instead of the formerly standard 2 percent 

fee. In exchange, the plan opted to sacrifice liquidity by agreeing to a 2-

year lockup of its investment, thus providing the fund manager with 

greater assurance that its capital and investment strategies would not be 

disrupted. While illiquidity by itself may be perceived as a disadvantage to 

an investor, this plan believed less liquidity was a worthwhile trade-off for 

lower fees.

Principles developed by private equity investors. Large pension plans and 

other institutional investors in private equity have, through the Institutional 

Limited Partners Association (ILPA), taken significant steps to promote 

more advantageous terms of investment, including lower fees and better 

fee terms. The ILPA Private Equity Principles address in some detail how 

fees should be aligned to the interests of investors. For example, ILPA 

principles advocate a fee arrangement that would help ensure that 

investors get back all invested capital, plus a specified return on 

investment as soon as these returns are available. Sometimes referred to 

as a “European waterfall”, this arrangement dictates that investors 

recover their full initial investment plus a specified return on investment—

such as an annualized 8 percent—before the fund manager obtains any 

Some Plans Have 

Improved Contractual 

Terms or Changed 

Investment Arrangements
 

Page 25 GAO-12-324 Defined Benefit Pension Plans

share of the profits.23

Enhanced transparency, control, and liquidity through separate accounts.

Many of the plans we contacted told us that some of the challenges of 

hedge fund investing could be addressed though the use of separate 

accounts in place of commingled funds. Under a commingled hedge fund 

arrangement, the investor owns a certain number of shares in the fund, 

but the hedge fund manager determines what assets to invest in, and the 

partnership collectively owns the underlying assets (see fig. 4). In 

contrast, under a separate account, the hedge fund manager essentially 

serves as a consultant who manages the assets in a way that generally 

parallels the hedge fund itself, but the investor may specify investment 

guidelines that result in differences between the commingled hedge fund 

and separate account. Plan representatives and financial industry experts 

cited multiple benefits of separate accounts, including (1) precise 

knowledge of the nature of underlying assets, (2) ability to exclude certain 

assets in the commingled hedge fund from its share of the rest of the 

hedge funds assets, and (3) much greater liquidity because plan 

sponsors own and can sell the underlying assets at will.

This arrangement contrasts with an “American 

waterfall”, under which the fund manager may collect profits 

corresponding to the sale of individual portfolio companies on a “deal by 

deal” basis, regardless of whether investors have obtained any return on 

their total investment in the fund. The overall advantage of the European 

waterfall for investors is that they can recapture their initial invested 

capital plus a specified return, as soon as that return exists, taking into 

account any losses. Further, because the fund manager does not obtain a 

share of the profits until after the investors have received the specified 

return, the need for reclamations of disbursements that have been made 

to the fund manager are minimized. Such reclamations—commonly 

referred to as “clawbacks”—may be necessary if profits paid to the fund 

manager based on the sale of portfolio companies early in the life of a 

fund are negated by subsequent losses. The ILPA Principles also 

address other issues, including notification of management changes and 

the fund management’s financial stake in the fund.

24

 

23A distribution “waterfall” is the method by which capital is distributed to funds investors 

as underlying investments are sold. The so-called “European” and “American” waterfalls 

are labeled as such because they reflect common practices in the respective markets. 

Separate 

24Plan officials explained that separate accounts can also be established for funds of 

hedge funds, or funds of private equity funds, in order to obtain benefits comparable to 

these described. For example, if a plan invests in a fund of hedge funds through a 

separate account, it can exclude an underlying hedge fund if it wishes. 
 

Page 26 GAO-12-324 Defined Benefit Pension Plans

account arrangements are, however, more costly than commingled funds, 

and hedge fund managers generally will not offer such arrangements 

unless the size of an investment exceeds a certain threshold.

Figure 4: Comparison of Commingled and Separate Accounts

Note: Separate accounts may be established through a variety of arrangements. For example, in 

some cases the underlying assets will be held in the name of the investor and in other cases in the 

name of the fund manager in a dedicated account.

Other steps. Plan sponsor representatives also mentioned other steps 

they took to address difficulties of the last several years. Some plans now 

seek specific contractual terms that affect liquidity or other aspects of the 

investment. For example, representatives of one plan explained that they 
 

Page 27 GAO-12-324 Defined Benefit Pension Plans

now seek investor level gates, under which cash-out limitations would be 

triggered once an investor has liquidated more than a specified amount of 

their investment. Other co-investors would not be affected and could still 

cash out under the normal terms of the hedge fund. Other plans have 

established certain criteria for selecting hedge fund or private equity 

funds. A representative of one plan, for example, said that the plan avoids 

hedge funds that have so-called side pockets—illiquid investments held 

separate from the primary fund—such as a hedge fund that has an 

investment in a private equity fund. A representative of one plan, which 

had been surprised by the existence of such side-pocket illiquid 

investments, noted that such investments can exacerbate illiquidity during 

stressful times. A representative of another plan noted that the plan 

prefers to select its own private equity investments and avoid locking in to 

one of a hedge fund manager’s choosing. Finally, a few plans made 

changes to overall portfolio management practices as a result of 

experiences with hedge funds and private equity. For example, one plan 

established a larger cash reserve and representatives of two plans 

described steps to enhance or monitor liquidity.

A few plan representatives and experts described other improvements to 

their selection or monitoring processes for hedge funds or private equity 

investments. For example, two plan sponsors said they are much more 

focused on how fund managers establish the value of invested shares.

One plan representative noted that, in the past, the plan took valuations 

provided by the fund manager at face value, but they now examine 

valuations much more closely. Representatives of other plans said that, 

as a result of massive hedge fund cash-outs by other co-investors, they 

consider the nature of other co-investors before investing. One plan 

representative explained that he prefers investors who will ride out market 

volatility and not flee the fund during episodes of volatility. Several 

surveyed experts cited diligence improvements, including better 

operational due diligence.25

 

25Operational due diligence involves examining operational risk, that is, the risk of 

investment loss due not to a faulty investment strategy, but from inadequate or failed 

internal processes, people and systems, or problems with external service providers. 

Such risk can arise from inexperienced operations personnel, inadequate internal controls, 

lack of compliance standards, or outright fraud. 

Some Plans Described 

Investment Selection and 

Due Diligence 

Improvements, but 

Practices May be Uneven
 

Page 28 GAO-12-324 Defined Benefit Pension Plans

Some public plans have also taken significant steps to improve and 

oversee the process of selecting hedge funds, private equity, and other 

investments. For example, a special review undertaken by one large 

public plan we contacted found significant problems involving the role of 

placement agents and accompanying malfeasance by public officials, 

which significantly compromised the plan’s selection of private equity 

funds and other investment vehicles.26 Among other things, the report 

raised the possibility that some private equity investments had been 

based on a relationship with a placement agent, rather than on the quality 

of the investment. Consequently, potentially superior investments may 

have been bypassed in favor of those with better connections, and the 

fund ultimately paid excessive fees that bore little or no relationship to the 

services rendered by the placement agent. The report’s conclusions 

emphasized that plan officials must increase vigilance on those portions 

of the plan—such as hedge funds and private equity—that have not 

traditionally been subject to as great a degree of public scrutiny as other 

types of investments. The review also offered numerous 

recommendations designed to prevent a recurrence of these events, and 

the plan has taken some actions. For example, the plan has advocated, 

and the California state legislature has enacted, a state law that imposes 

on placement agents the same disclosure and registration requirements 

that apply to lobbyists, and obtained over $200 million in fee reductions 

and an agreement from elite money management firms to avoid using 

placement agents for new plan investments. Further, partly as a result of 

the review, the plan developed a comprehensive new policy designed to 

ensure that it had more advantageous terms of investment with its hedge 

fund managers. According to a representative of the National Association 

of State Retirement Administrators, other public plans have experienced 

similar problems and have made comparable reforms.27

 

26Report of the CalPERS Special Review, Steptoe and Johnson LLP and Navigant 

Consulting Inc., March 2011. Placement agents are intermediaries or middlemen paid by 

external money managers to help gain access to capital from institutional investors. 

27The National Association of State Retirement Administrators is a nonprofit organization 

whose members are the directors of the nation’s state, territorial, and largest statewide 

public retirement systems. 
 

Page 29 GAO-12-324 Defined Benefit Pension Plans

Although some plans have taken significant steps to improve the terms of 

hedge fund and private equity investments in recent years, not all plans 

may be able to take such steps, and it is not clear how extensive such 

changes have been. For example, separate accounts may not be a 

practicable option for all plan sponsors. Separate accounts impose 

additional duties on hedge fund managers and, therefore, the fees 

associated with them are often somewhat higher. In addition, they impose 

additional burdens on the investor, such as ensuring that the 

management of the separate account matches that of the commingled 

fund. Further, according to plan sponsors and experts, hedge fund 

managers will establish and operate separate accounts only for 

investments of a certain magnitude; hedge fund managers may not 

establish separate accounts for investments of less than approximately 

$100 million. As a result, separate accounts would not be an option for 

plans unable to make an investment of this magnitude.

Although our survey of experts identified some of the same actions that 

plan representatives described, the narrative responses revealed no clear 

pattern or consensus regarding these actions. Further, plan 

representatives and some experts indicated that not all plans would be 

able to take the steps described above. For example, plans’ ability to 

obtain better fee terms is not universal. One plan representative noted 

that his plan is not large enough to have much negotiation power with 

fund managers, and the plan generally accepts the manager’s standard 

fee structure. Another plan representative noted that the top fund 

managers have not had to adjust fees. Also, with regard to due diligence 

steps, some surveyed experts indicated that difficulties are likely to be 

among smaller plans or plans with lesser resources. For example, one 

respondent stated that while the use of best practices is becoming more 

widespread, failure to observe them occurs among smaller funds that lack 

resources or plans that are influenced by a salesperson.

Finally, it is not clear whether some of the changes in recent years will 

permanently change the landscape. One of the leading plan consultants 

noted that, since the financial crisis, plans have gained significant 

bargaining power with hedge fund managers who desire plan 

investments. However, representatives of two plans also indicated that 

this development may be cyclical, and an outgrowth of the troubled 

financial markets in recent years. These representatives also speculated 

that, when financial markets heat up again, the environment may change 

to a “seller’s” market, and fund managers may be able to reassert fee 

structures and other investment terms that are less advantageous to 

investors.

Plans May Have Limited 

Ability to Take Certain 

Steps 
 

Page 30 GAO-12-324 Defined Benefit Pension Plans

Various entities have developed guidance applicable to plan investments 

in hedge fund and private equity, ranging from broadly applicable 

guidance issued by Labor to detailed guidance issued by federal advisory 

and industry bodies. While Labor has not developed guidance specifically 

addressing hedge funds or private equity, departmental officials cited a 

1996 information letter from Labor to the Comptroller of the Currency that 

discusses the application of ERISA principles regarding the use of 

alternative investments.28 The letter does not refer to hedge funds or 

private equity, but departmental officials said that its basic principles 

could be applied to these types of investments. The letter addresses 

pension plans’ use of derivatives in their investment portfolios and states 

that investments in derivatives are subject to ERISA fiduciary 

responsibility rules, just as any other investment.29

• Sophistication. Such investments may require more sophistication and 

a deeper understanding on the part of fiduciaries than other 

investments.

In light of this, the 

letter emphasizes several key considerations, including

• Adequate information. Fiduciaries are responsible for obtaining 

sufficient information to understand such investments and, if the 

investment is in a pooled fund managed by another entity, the 

fiduciary should obtain sufficient information to determine the nature 

of the pooled fund’s uses of derivatives.

• Understanding of investment risk. The market risks of these 

investments should be understood and evaluated in terms of, among 

other considerations, the effect they have on the portfolio’s overall 

risk. 

• Understanding operational and legal risk. The fiduciary must 

determine whether it has adequate information and risk management 

systems in place given the nature, size, and complexity of the 

investment, and must ensure proper documentation of a derivative 

transaction.

 

28Letter from Department of Labor to the Comptroller of the Currency, March 21, 1996. 

29Derivatives are financial instruments that are based on the price movements of 

underlying assets. Common types of derivatives include futures and options.

Federal Entities and 

Others Have 

Developed Guidance 

Addressing Hedge 

Funds and Private 

Equity 
 

Page 31 GAO-12-324 Defined Benefit Pension Plans

While Labor has issued this general guidance applying to investments in 

derivatives, other organizations have published guidance specifically 

encompassing or targeted at hedge fund and private equity. In December 

2011, the Organisation for Economic Cooperation and Development 

(OECD) and the International Organisation of Pension Supervisors 

(IOPS) published a set of good practices for pension plans’ use of 

alternative investments, including hedge funds and private equity.30

Based on a survey of OECD and IOPS members, this document offers 

recommended good practices on issues such as investment policy, risk 

management, and contractual terms, as well as best practices for pension 

fund regulators. In 2009, the President’s Working Group on Financial 

Markets31 issued a report detailing important considerations and best 

practices for hedge fund investors, including specific guidance for 

fiduciaries.32 This document provides basic background information about 

hedge funds, distinguishes them from more traditional investments, and 

outlines some of the basic considerations a fiduciary should make in the 

earliest stages of considering a hedge fund investment. The document 

also provides extensive guidance and suggestions for best practices 

related to due diligence steps, risk management, and various challenges 

involved in hedge fund investing, including valuation, fees and expenses, 

and legal and regulatory considerations, among other issues. Similarly, 

the Greenwich Roundtable, a nonprofit research and educational 

organization for investors in alternative assets, has issued a document 

that outlines due diligence best practices for alternative investments, 

including hedge fund and private equity investments.33

 

30OECD/IOPS, Good Practices on Pension Funds’ Use of Alternative Investments and 

Derivatives, Organisation for Economic Cooperation and Development and International 

Organisation of Pension Supervisors (December 2011). IOPS is an international body 

representing those involved in supervision of private pension arrangements. Membership 

includes representatives from about 60 countries and territories. OECD consists of 34 

member countries, and seeks to promote policies that will improve economic and social 

well-being.

This document 

31Established by executive order in 1988, the President’s Working Group on Financial 

Markets is composed of top officials of the Department of the Treasury, the Board of 

Governors of the Federal Reserve, the SEC, and the Commodity Futures Trading 

Commission. (53 Fed. Reg. 9421, 3 C.F.R., 1988 Comp., p. 559).

32Principles and Best Practices for Hedge Fund Investors: Report of the Investors’ 

Committee to the President’s Working Group on Financial Markets (Jan. 15, 2009).

33Best Practices in Alternative Investments: Due Diligence, Education Committee of the 

Greenwich Roundtable (2010).
 

Page 32 GAO-12-324 Defined Benefit Pension Plans

describes basic considerations in the process of considering any 

alternative investment, and it separately provides in-depth guidance on 

specific steps that should be taken in making hedge fund, private equity, 

and other illiquid investments.

In addition to these guidance documents, other organizations have 

published briefer guidance documents. In 2008, the Government Finance 

Officers Association published a brief advisory on the use of alternative 

assets by public employee retirement systems.34

In recent years, we and the ERISA Advisory Council have separately 

recommended that Labor take steps to help ensure that plans wishing to 

invest in hedge funds and private equity do so carefully.

This three-page 

document presents a condensed explanation of the risks inherent in 

investing in hedge funds, private equity, and other alternative assets. It 

also highlights key due diligence considerations and recommends that 

state and local governments use extreme prudence in making such 

investments. More recently, the ILPA published a set of principles aimed 

at defined benefit pension plans and other institutional investors in private 

equity. This document details important aspects of the terms of 

investment between fund managers and investors, and best practices that 

fund managers and investors should observe during the course of the 

investment relationship.

35 In 2008, we 

recommended that the Secretary of Labor provide guidance to fiduciaries 

of ERISA Title I plans that would, among other things, outline the unique 

challenges of such investments, outline the steps plans should take to 

address these challenges, and highlight the implications of these 

challenges for smaller plans.36

 

34The Use of Alternative Investments for Public Employee Retirement Systems and Other 

Post Employment Benefit (OPEB) Established Trusts (2000 and 2008) (CORBA), 

Government Finance Officers Association (October 2008).The Government Finance 

Officers Association is a professional association of state, provincial, and local finance 

officers in the United States and Canada. 

The ERISA Advisory Council has twice

made comparable recommendations. In 2006, the council recommended 

that Labor publish guidance about the unique features of hedge funds 

35The Advisory Council on Employee Welfare and Pension Benefit Plans, commonly 

referred to as the ERISA Advisory Council, was created by ERISA to provide advice to the 

Secretary of Labor. 29 U.S.C. § 1142. 

36GAO-08-692. 
 

Page 33 GAO-12-324 Defined Benefit Pension Plans

and matters for consideration in their adoption for use by qualified plans.37

While the council concluded that hedge funds may be an acceptable form 

of investment, its report noted that certain aspects of hedge fund 

investments should be brought to the forefront in educating plan 

fiduciaries and others. Among these are investment styles, liquidity 

issues, and potential conflicts of interest. In 2008, the council reviewed 

hard-to-value assets, which can include hedge funds, private equity, and 

other alternative assets.38 39

In 2011, the ERISA Advisory Council specifically revisited the issue of 

pension plans’ investments in hedge funds and private equity. The 2011 

sessions of the council’s hearings prominently considered the potential 

role of hedge fund and private equity investments in retirement plans. The 

council’s report has not yet been published, but according to a Labor 

official, publication is expected in early 2012.

As a result of related hearings and 

deliberations, the council recommended that Labor issue guidance 

addressing the complex nature and distinct characteristics of such assets.

The council further specified that the guidance should define hard-tovalue assets and describe ERISA obligations when selecting, valuing, 

accounting for, monitoring, and reporting on these assets. To date, Labor 

has implemented neither our recommendations nor the council’s 

recommendations. In responding to our 2008 recommendation, Labor 

noted that while it would consider the recommendation, the lack of 

uniformity among hedge funds and private equity funds could make 

development of comprehensive and useful guidance difficult.

Plans and their hedge fund and private equity investments have not been 

immune to the effects of the financial market turbulence in recent years. 

Despite significant losses, however, DB plan sponsors and experts we 

contacted generally indicated that these alternative assets had met 

expectations and still had a significant role to play in the plans’ investment 

 

37U.S. Department of Labor ERISA Advisory Council, Report of the Working Group on 

Prudent Investment Process (November 2006). 

38U.S. Department of Labor ERISA Advisory Council, Report on Hard to Value Assets and 

Target Date Funds (2008). 

39Hard-to-value assets are those that are not listed on any national exchanges or overthe-counter markets, or for which quoted market prices are not available. 

Concluding 

Observations 
 

Page 34 GAO-12-324 Defined Benefit Pension Plans

portfolios. Data from surveys of public and private plans clearly indicate 

that the appetite for such investments is continuing to grow.

Nonetheless, the events of the last 4 years have reinforced our 2008 

observation that hedge funds and private equity also pose risks and 

challenges beyond those posed by more traditional investments. 

Representatives of some of the plans that we contacted indicated that 

hedge fund investments were less resilient than expected. As a result of 

poor performance or other issues related to hedge funds and private 

equity, some plans have taken significant steps to adjust the nature or 

terms of such investments. These steps will likely benefit the plans and, 

therefore, the plan participants and beneficiaries, in coming years.

Although some plans have taken significant actions, it is not clear how 

extensive such changes have been and whether such changes would be 

practical for those DB plans that lack both the resources and the 

negotiating power available to other plans. Our selection of 22 DB plans 

included some of the largest retirement plans in the nation, some of which 

manage tens of billions of dollars. Yet despite their size and expertise, 

some of these plans encountered significant difficulties with their 

alternative investments in recent years, resulting in substantial 

adjustments to plan investment practices. It is worth asking, if such large, 

sophisticated institutions can have difficulties that result in significant 

changes in the nature or terms of their investment in these alternative 

asset classes, how much more difficult it might be for medium and smaller 

plans.

In 2008, we recommended that the Secretary of Labor issue guidance 

designed for qualified plans under ERISA concerning alternative 

investment practices. We specifically called for guidance that would (1) 

outline the unique challenges of investing in hedge funds and private 

equity; (2) describe steps that plans should take to address these 

challenges and help meet ERISA requirements; and (3) explain the 

implications of these challenges and steps for smaller plans. We still 

believe that providing such guidance would be beneficial. In fact, in light 

of the guidance documents issued by other national and international 

organizations in the intervening years, this task might now prove easier 

for Labor than it would have been 4 years ago. Such guidance still has 

the potential to help plan sponsors, and our work suggests a continued 

need for such assistance.
 

Page 35 GAO-12-324 Defined Benefit Pension Plans

We provided a draft of this report to the Department of Labor, Department 

of the Treasury, the Pension Benefit Guaranty Corporation, and the 

Securities and Exchange Commission (SEC) for review and comment. 

Labor, the Department of the Treasury, and SEC provided technical 

comments which we incorporated as appropriate.

As agreed with your office, unless you publicly announce the contents of 

this report earlier, we plan no further distribution until 30 days from the 

report date. At that time, we will send copies of the report to the 

appropriate congressional committees, the Secretary of Labor, Secretary 

of the Treasury, the Director of the Pension Benefit Guaranty Corporation, 

Director of the SEC, and other interested parties. This report will also 

available at no charge on the GAO website at http://www.gao.gov. 

If you or your staff have any questions regarding this report, please 

contact Charles Jeszeck at (202) 512-7215 or jeszeckc@gao.gov . 

Contact points for our Offices of Congressional Relations and Public 

Affairs may be found on the last page of this report. Key contributors are 

listed in appendix II.

Sincerely yours,

Charles Jeszeck, Director

Education, Workforce

 and Income Security Issues

Agency Comments
Appendix I: Objectives, Scope, and 

Methodology

Page 36 GAO-12-324 Defined Benefit Pension Plans

Our objectives were to answer the following research questions:

• What is known about the experiences of defined benefit pension plans 

with investments in hedge funds and private equity, including recent 

lessons learned?

• How have plan sponsors responded to lessons learned from recent 

experiences with such alternative investments?

• What steps have federal agencies and other entities taken to help 

plan sponsors make and manage investments in such alternative 

assets, and what additional steps might be warranted?

To answer all of the research questions, we conducted in-depth 

interviews with plan representatives of the private and public sector 

pension plans that were selected for our 2008 report examining the extent 

to which pension plans invest in hedge funds and private equity.1

 

1

While 

26 plans were interviewed for the 2008 report, 22 plans participated in 

follow-up interviews for our report (see table 3 for a list of plan officials we 

interviewed). We conducted interviews with representatives from June 

2011 to September 2011 and, we obtained and reviewed available 

supporting documentation. These interviews were conducted using a

semistructured interview format, which included open-ended questions on 

the following topics, asked separately about each plan’s hedge funds or 

private equity investments: history of investment in hedge funds or private 

equity; experiences with these investments to date; lessons learned with 

these investments; changes made to address these lessons, including 

due diligence and ongoing monitoring; and actions federal agencies, such 

as Labor, should take to ensure that pension plan fiduciaries better make 

and manage their hedge fund and private equity investments. Four of the 

plans, who did not invest in hedge funds when we interviewed them for 

our 2008 report, were included in our in-depth interviews to determine 

whether plan representatives subsequently invested in hedge funds and 

to determine their experience given that decision. The results of the plan 

sponsor interviews were limited by plan representatives’ willingness to 

speak with us.

GAO-08-692. 

Appendix I: Objectives, Scope, and 

Methodology 
Appendix I: Objectives, Scope, and 

Methodology

Page 37 GAO-12-324 Defined Benefit Pension Plans

Table 3: List of Pension Plans Interviewed 

Interviewed for 2008 report Interviewed for 2012 report 

Private plans 

1. American Airlines √

2. Boeing 

3. Exxon Mobil √

4. GE Asset Management √

5. International Association of Machinists National 

Pension Fund 

√

6. John Deere 

7. Macy’s √

8. Northrop Grumman √

9. Prudential √

10. Target √

11. United Mine Workers of America Health and 

Retirement Funds 

√

12. United Technologies √

13. Walt Disney √

Public plans

14. California Public Employees’ Retirement System √

15. California State Teachers’ Retirement System √

16. Illinois State Board of Investment √

17. Los Angeles County Employee Retirement 

Administration 

18. Massachusetts Pension Reserves Investment 

Management Board 

√

19. Missouri State Employees’ Retirement System √

20. National Railroad Retirement Investment Trust 

Fund 

√

21. New York State Common Retirement Fund 

22. Pennsylvania Public School Employees’ 

Retirement System 

√

23. Pennsylvania State Employees’ Retirement 

System 

√

24. San Diego County Employees’ Retirement 

Association 

√

25. South Dakota Retirement System √

26. Washington State Investment Board √

Source: GAO.
Appendix I: Objectives, Scope, and 

Methodology

Page 38 GAO-12-324 Defined Benefit Pension Plans

Note: Four of the plans interviewed did not invest in hedge funds when we interviewed them in 2008. 

One of these plans subsequently decided to invest in hedge funds.

The plans we interviewed were selected based on several criteria 

identified in our 2008 report. Specifically, when these plans were selected 

for our prior report, we attempted to select plans that varied in the size of 

allocations to hedge funds and private equity as a share of total plan 

assets. We also attempted to select plans with a range of total plan 

assets, as outlined in table 4. We identified these plans using data from 

the 2006 Pensions & Investments survey of the largest 200 pension plans 

and through our interviews with industry experts. While we selected plans 

representing a range of total plan assets and varying size of allocations to 

hedge funds and private equity as a share of total plan assets, these plan 

representatives’ responses do not represent a statistically generalizeable 

sample of all pension plans.

Table 4: Criteria Used in 2008 Selection of Plans for In-Depth Interviews 

Hedge funds Private equity

Size of allocation to hedge funds or private equity

None 5 

5% or less 10 5 

>5 to 10% 3 6 

>10% 2 2 

Total plan assets 

$10 billion or less 8 5 

>$10 to $100 billion 9 5 

>$100 billion 3 3 

Source: GAO analysis of Pensions & Investments 2006 survey.

To further address the research questions, we surveyed a selected group 

of 20 experts in the areas of pension plan hedge fund and private equity 

investment. We asked these experts five questions related to 

performance and management of these funds during the past 5 years and 

also requested suggestions, if any, for regulatory improvements.

Specifically, we asked how pension plans’ hedge fund and private equity 

investments have performed; lessons learned with respect to pension 

plan hedge fund and private equity investments; changes to pension plan 

hedge fund and private equity investment practices; the extent to which 

pension plans observe best practices in hedge fund and private equity 

due diligence; and actions federal agencies, such as Labor, should take 

to ensure that pension plan fiduciaries better make and manage their 
Appendix I: Objectives, Scope, and 

Methodology

Page 39 GAO-12-324 Defined Benefit Pension Plans

hedge fund and private equity investments. We used a Web-based form 

to collect responses. This group of experts was selected from a number 

of sources, including experts from our 2010 GAO Retirement Security 

Advisory Panel, referrals from interviews and other experts, and 

recommendations from GAO subject matter experts. To ensure we had a 

range of views we invited participants from several different backgrounds 

to participate in our survey including academics, representatives of public 

and private plan sponsors, representatives of plan participants, pension 

consultant groups, and other key national organizations and subject 

matter experts. Of the 20 experts who agreed to participate in the survey, 

19 completed the questionnaire within the requested time frame. The 

survey was conducted in August 2011.

To quantitatively address national hedge fund and private equity 

investment performance for the first question, we obtained and reviewed 

broad industry performance data from two private organizations, 

Cambridge Associates LLC and Hedge Fund Research, Inc.2

While the data from each of these organizations are limited in some ways, 

we conducted data reliability assessments for each data source and 

determined that the data were sufficiently reliable for purposes of this 

study. Data from these organizations are not specific to pension plan 

hedge fund and private equity investments, which may have different 

investment performance due to specific investment terms and industry 

access. Moreover, because these data were from broad investment 

indexes, they neither illustrated differences in performance for various 

investment strategies within hedge fund and private equity investments, 

nor did they distinguish performance of fund of funds investment. While 

the most informative way to assess how well investments have performed 

is to analyze actual portfolio investment data, we were unable to 

quantitatively analyze specifically how pension plans’ investments in 

hedge funds and private equity have performed over the past 5 years. We 

attempted to obtain detailed investment performance data from selected 

Data from 

these organizations captured historical hedge fund and private equity 

investment performance, including performance at the peak of the 

financial crisis. We used these data to determine broad hedge fund and 

private equity performance over the last 5 years.

 

2

Cambridge Associates LLC is a private and institutional investment consulting and 

research firm and Hedge Fund Research, Inc. is an investment research firm specializing 

in the areas of indexation and analysis of hedge funds.
Appendix I: Objectives, Scope, and 

Methodology

Page 40 GAO-12-324 Defined Benefit Pension Plans

custodian banks and investment consulting firms. These two groups have 

data on the largest pension plan investments in the country. However, 

because of the proprietary nature and considerable cost, both in 

resources and expense, we were not able to conduct this analysis.

To address the second question, we obtained and analyzed survey data 

of private and public sector defined benefit plans on the extent of plan 

investments in hedge funds and private equity from two private 

organizations, Greenwich Associates and Pensions & Investments.

3 We 

identified these two surveys from prior work and obtained updated 2010 

data.4

While the information collected by each of the surveys is limited in some 

ways, we conducted a data reliability assessment of each survey and 

determined that the data were sufficiently reliable for purposes of this 

study. These surveys did not specifically define the terms hedge fund and 

private equity; rather, respondents reported allocations based on their 

own classifications. Data from both surveys are reflective only of the 

plans surveyed and cannot be generalized to all plans.

As seen in table 5, the surveys varied in the number and size of 

plans surveyed. Using available survey data, we determined the 

percentage of plans surveyed that reported investments in hedge funds or 

private equity. Using data from Greenwich Associates, we also 

determined the percentage of surveyed plans that invested in hedge 

funds or private equity by category of plan size, measured by total plan 

assets. We further examined data from each survey on the size of 

allocations to hedge funds or private equity as a share of total plan 

assets. Using the Pensions & Investments data, we analyzed allocations 

to these investments for individual plans and calculated the average 

allocation for hedge funds and private equity, separately, among all plans 

surveyed that reported these investments. The Greenwich Associates 

data reported the size of allocations to hedge funds or private equity as 

an average for all plans surveyed.

 

3

Greenwich Associates is an institutional financial services consulting and research firm 

and Pensions & Investments is a money management industry publication. 

4

GAO-08-692. 
Appendix I: Objectives, Scope, and 

Methodology

Page 41 GAO-12-324 Defined Benefit Pension Plans

Table 5: Number and Size of Pension Plans Observed in Recent Surveys 

Greenwich Associates 

(2010) 

Pensions & Investments 

(2010) 

Sample size 564 pension plans 131 pension plans 

Total assets of plans in 

survey 

$4.3 trilliona $3.1 trillion 

Range of total plan assets $250 million or more $1.7 billion or more 

Sources: Greenwich Associates and Pensions & Investments. 

Note: Pensions & Investments surveyed the largest 200 plans, ranked by combined defined benefit 

and defined contribution plan assets. Of the top 200 plans, 131 were defined benefit plans that 

completed the survey and provided asset allocation information. Greenwich Associates surveyed 590 

plans; however, we excluded 24 unions and 2 endowments and foundations from our analysis.

a

To address the third question, we first reviewed relevant literature and 

spoke with federal officials from relevant agencies, including the Labor, 

the SEC, and the Pension Benefit Guaranty Corporation to understand 

federal agency action to date. In addition, we interviewed key national 

organizations and pension industry experts to understand the perspective 

of plan officials and their participants regarding federal actions to date, as 

well as then need for additional federal action. Key national organizations 

included representatives from organizations that represent plan 

participants, such as AARP, and an organization that represents plan 

officials, the American Benefits Council. In addition, we interviewed 

academic and national experts in the pension and alternative investment 

area and pension plan consultants. We also attended and participated in 

Labor’s ERISA Advisory Council 2011 hearings on pension plan 

investments in private equity and hedge funds, including the use of these 

investments in defined contribution plans.

Total assets for the 564 surveyed private and public plans projected to approximately 1,200 private 

plans and 325 public plans.

5

We conducted this performance audit from February 2011 to February 

2012 in accordance with generally accepted government auditing 

standards. Those standards require that we plan and perform the audit to 

We reviewed and analyzed the 

detailed information collected through the literature review, discussions, 

and hearings to determine actions taken to date by federal agencies and 

other entities to help plan sponsors make and manage hedge fund and 

private equity investments.

 

5

GAO-11-901SP. 
Appendix I: Objectives, Scope, and 

Methodology

Page 42 GAO-12-324 Defined Benefit Pension Plans

obtain sufficient, appropriate evidence to provide a reasonable basis for 

our findings and conclusions based on our audit objectives. We believe 

that the evidence obtained provides a reasonable basis for our findings 

and conclusions based on our audit objectives.
Appendix II: GAO Contact and Staff 

Acknowledgments

Page 43 GAO-12-324 Defined Benefit Pension Plans

Charles A. Jeszeck, Director, (202) 512-7215, or jeszeckc@gao.gov

David Lehrer, Assistant Director, and Michael Hartnett, Analyst-inCharge, managed this review.

Amber Yancey-Carroll also led portions of the research and made 

significant contributions to all portions of this report.

Kathleen van Gelder helped develop the structure of the report, and 

Luann Moy provided methodological assistance. Sheila McCoy and 

Roger Thomas provided legal assistance. Ashley McCall assisted in 

identifying relevant literature. James Bennett developed the report’s 

graphics. Caitlin Croake and Lauren Gilbertson verified our findings.

Appendix II: GAO Contact and Staff 

Acknowledgments 

GAO Contact

Staff 

Acknowledgments 

(131062)
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