U.S. pension plan sponsors are hiring new investment managers at an unprecedented rate, as they try to squeeze added returns from their portfolios.

According to financial services consulting firm Greenwich Associates’ 2004 report on the U.S investment management industry, the recent recovery in global equity markets has failed to alleviate the funding gaps that arose within many U.S. pension plans during the bear market.

In need of increased returns, institutional investors are trying to squeeze greater returns out of traditional core debt and equity holdings, and increasing their investments in potentially higher yielding alternative asset classes, the report says.

“U.S. pension funds are opening their doors to new managers and looking for fresh insights and ideas to a greater extent than we’ve seen in 30 years of covering this market,” said Greenwich Associates consultant Rodger Smith, in a news release. “They’re not abandoning their traditional asset allocations and classes, but they are shopping smarter.”

Although U.S. institutional investors racked up impressive gains during last year’s strong equity market performance, these returns have been largely offset by consistently low interest rates, which have the effect of increasing the pension funds’ future obligations, Greenwich reports. In response, plan sponsors are sticking with their long-term allocation plans while looking for ways to tweak their current asset mix to provide opportunities for enhanced returns, without taking on significant amounts of risk, Greenwich finds. To accomplish this, they are hiring new managers at a brisk pace. “Sponsors are looking to these new managers for creative ideas and incremental diversification,” said Greenwich consultant Dev Clifford.

This diversification is taking part within traditional asset classes, as plan sponsors shift to slightly more exotic instruments with marginally higher risks and potentially larger returns, Greenwich says. For example, funds are replacing core equities with enhanced indexes in many portfolios. They are also bolstering their traditional bond holdings with global bonds, high yield bonds, and even private placements. Plan sponsors are also replacing some of the basic equities in their international portfolios with slightly riskier stocks in emerging markets.

Hedge fund use by U.S. pension funds, endowments, and foundations remained on a steep upward curve throughout 2003, Greenwich says, with 23% of funds reporting hedge fund use as compared to just 12% in 2000. The dramatic influx of pension assets into hedge funds is beginning to have profound effects on the asset class. “Corporate and public pension funds report a 5% average target allocation for hedge funds,” said Greenwich consultant Chris McNickle. “If they reached that level, hedge fund investment would total some US$250 billion, including assets from endowments and foundations. Those levels call into question current hedge fund capacity.”

Also, U.S. pension fund assets invested in equity real estate jumped from US$175 billion in 2002 to US$192 billion in 2003 — roughly 50% higher than investment levels of the late 1990s. Within the asset class, plan sponsors are moving into opportunity funds and out of separate portfolios. “There are more plan sponsors investing in equity real estate today, and those that do invest are putting more money into the asset class,” said Smith. “As in the case of other asset classes, they are looking for ways to add some degree of risk and, hopefully, increase returns.”