Worsification: Diversification Gone Bad

The North Carolina State Retirement System's pension fund is a perfect example of what I call "worsification" or diversification gone bad.  If one takes a look at the most recent investment performance report by clicking here.  You will notice six asset classes:

1. Global Equity (publicly traded stocks)
2. Fixed Income (publicly traded bonds)
3. Real Estate (partnerships that buy shopping malls and office buildings)
4. Alternatives (private equity, venture capital, hedge funds)
5. Credit (junk bonds and bank loans)
6. Inflation (derivative securities on commodities: eg. futures and options on gold or corn, etc.)

Most folks are familiar with the first two categories which are just traditional stocks and bonds.  But, the next four categories might come as a surprise to some pensioners to discover their retirement is being bet on such items as private equity, hedge funds, junk bonds, and derivatives.  The worst part of the surprise is that the four new categories have all produced returns lower than a simple, traditional, 60% / 40% mix of stocks and bonds.

NCRS 10-year returns
Stocks = 8.0%
Bonds = 6.8%
60/40 Stock/Bond = 7.5%
Alternatives = 5.3%
Real Estate = 3.8%