Pension funds seek returns on private assets as public market outlook darkens

Large funding gaps are driving pension plans to invest money in private assets in search of returns, increasing the risk of overloaded transactions and moderate earnings, a new study finds.

The report from Amundi, Europe’s largest asset manager, and Create Research studied 152 defined benefit pension plans managing € 2.1 billion in assets. His findings illustrate the scale of the challenges facing the global pension industry as it seeks to escape the punitive effect of historically low bond yields as well as high valuations in equity markets.

The funds have been bolstered since the 2008-09 financial crisis by a strong recovery in equity markets which has helped counter the lackluster flow of interest payments provided by holding government or corporate debt. But many managers are now worried about growing headwinds: just over seven in ten respondents in the survey say they expect significantly lower returns in the years to come.

“This was not how the final phase of defined benefit plans was supposed to play out,” said Amin Rajan, CEO of Create Research. “Three things conspired against them: low interest rates, an aging demographics and an immediate need for liquidity in an era of low interest rates. ”

Defined benefit pension plans, which promise guaranteed retirement income that rises with inflation, have traditionally been led by regulators to hold assets that match their flow of liabilities, such as bonds.

The problem has been compounded in recent months by a sharp rise in prices around the world which has made it difficult to find well-rated bonds offering positive returns after factoring in inflation.

The low interest rate environment is forcing pension managers to seek returns in other markets, especially unlisted assets.

Rajan estimates that defined benefit plans increased their allocation to private assets from five percent 15 years ago to around 20 percent today. They continue to increase their private allocations, attracted by the prospect of capital growth, income and inflation protection, he said.

Private asset holdings – which include private debt, private equity, real estate and infrastructure – are set to increase 60% between 2020 and 2025, to exceed $ 17 billion in assets under management, according to the provider data Preqin.

However, Rajan warned that as managers rushed into private assets, they faced increased competition, especially from the world’s largest pension funds, and risked paying too much for the assets.

“Private assets are a highly dispersed space, which means there is a big difference between the best and the worst managers. This means that the selection of managers is vital, ”he said. “Although the money is pouring into the private market, there is no guarantee that it will generate big returns. For the moment, the set of opportunities is limited.

It is also often more difficult and costly for investors to buy, sell and value private investments since they do not trade in public markets.

About 75% of pension funds that responded to the survey said they were pursuing low-risk strategies before the pandemic. Of this cohort, about a third were now redeploying their capital in search of higher returns.

“Getting into risky assets is not the best option for some plans, but unfortunately it is their only option,” said Pascal Blanqué, group investment director at Amundi.

Earlier this month, the board of directors of the California Public Employees’ Retirement System, the largest pension fund in the United States, voted in favor of using borrowed money and alternative assets to help him achieve his return on investment goal. In July, the C $ 221 billion Ontario Teachers’ Pension Plan unveiled plans for a further C $ 70 billion surge in private markets, covering assets ranging from infrastructure to infrastructure. real estate.