Where do pension funds typically invest?

A superannuation plan is a retirement plan that requires an employer to make contributions to a pool of funds set aside for a worker’s future benefits. The fund pool is invested in the employee’s name, and earnings on the investments generate income for the retired worker. Pension fund assets must be managed carefully to ensure that retirees receive the promised retirement benefits. For many years, this meant that funds were limited to investing primarily in government securities, investment grade bonds and blue chip stocks.

Changing market conditions and the need to maintain a sufficiently high rate of return have resulted in pension plan rules that permit investments in most asset classes. These are some of the most common investments to which pension funds allocate their substantial capital. Here we look at some of the asset classes that pension funds are likely to own.

Key points to remember

  • Pension fund assets must be managed to ensure that eligible retirees receive the benefits they have been promised.
  • Until relatively recently, pension funds invested primarily in stocks and bonds, often using a liability matching strategy.
  • Today, they are increasingly investing in a variety of asset classes, including private equity, real estate, infrastructure, and securities like gold that can hedge inflation.

Pension plans, also known as defined benefit plans, ensure that employees receive a fixed payment regardless of investment performance.

Fixed income investments

US Treasuries and investment grade bonds continue to be a key component of pension fund portfolios. Investment managers looking for higher yields than those offered by conservative fixed-income instruments have turned to high-yield bonds and well-secured commercial real estate loans. Portfolios with asset-backed securities (ABS), such as student loans and credit card debt, are on the rise. However, the risk associated with these securities tends to be somewhat higher than typical corporate or government bonds.

As an example of the prevalence of fixed-income securities in retirement portfolios, the largest retirement plan in the United States, the California Public Employees’ Retirement System (“CalPERS”), targets an annual return of 7% ,Inasmuch aswith around a third of its $385.1 billion portfolio allocated to fixed income investments as of March 2020.Inasmuch asInasmuch as

Shares

Equity investments in high-quality common and preferred stocks in the United States are an important category of investments for pension funds.Inasmuch asManagers traditionally focus on dividends combined with growth. The search for higher yields has pushed some fund managers towards riskier small-cap growth stocks and international stocks.

Larger funds, such as CalPERS, manage their equity portfolios themselves. Smaller funds are likely to seek external management or invest in institutional versions of the same mutual funds and exchange-traded funds (ETFs) as individual investors. The main difference here is that institutional share classes have no upfront sales, redemption, or 12b-1 fees, and they charge a lower expense ratio.

Capital investment

Institutional investors, such as pension funds, and those classified as accredited investors invest in private equity, an alternative long-term investment category suitable for sophisticated investors. In fact, pension funds are one of the most important sources of capital for the private equity industry.Inasmuch asInasmuch as

In its purest form, private equity represents managed pools of money invested in the capital of private companies with the intention of eventually selling the investments for substantial gains. Private equity fund managers charge high fees based on promises of above-market returns.

$8.6 trillion

The amount of assets under management by public and private sector pension plans in the United States at the end of 2018, according to the Investment Company Institute.

Immovable

Pension fund real estate investments are generally passive investments made through real estate investment trusts (REITs) or private equity pools. Some pension funds operate property development departments to participate directly in the acquisition, development or management of properties.

Long-term investments are in commercial real estate, such as office buildings, industrial parks, apartments or retail complexes. The aim is to create a portfolio of properties that combine equity appreciation with a growing stream of inflation-adjusted income to balance the ups and downs of the markets.

Infrastructure

Investments in infrastructure remain a small part of most pension plan assets, but they are a growing market for a diverse assortment of public or private developments involving power, water, roads and infrastructure. energy. Public projects are limited by budgets and the borrowing power of civil authorities. Private projects require large sums of money that are expensive or difficult to raise. Pension plans can invest with a longer term perspective and the ability to structure creative funding.

Typical financial arrangements include a base payment of interest and principal to the fund, as well as some form of income or equity participation. A toll road may pay a small percentage of the tolls in addition to the financing payment. A power plant may pay a little for each megawatt generated and a percentage of the profits if another company buys the plant.

Inflation protection

Inflation protection is a term used to refer to assets that tend to increase in value as inflation rises. These can include inflation-adjusted bonds (eg TIPS), commodities, currencies and interest rate derivatives. The use of inflation-adjusted bonds is often justified, but increasing the allocation of pension fund assets to commodities, currencies or derivatives has raised concerns among some due to the risk additional idiosyncratic character they carry.

Liability matching, also known as “immunization,” is an investment strategy that matches future asset sales and income streams to the timing of expected future expenditures. The strategy has become widely adopted by pension fund managers, who attempt to minimize the risk of portfolio liquidation by ensuring that asset sales, interest and dividend payments match expected payments to beneficiaries. pension. This contrasts with simpler strategies that attempt to maximize return without considering the timing of the withdrawal.

For example, pensioners living on income from their portfolio generally rely on stable and continuous payments in addition to social security contributions. A matching strategy would involve the strategic purchase of securities to pay dividends and interest at regular intervals. Ideally, a matching strategy should be in place long before the retirement years begin. A pension fund would employ a similar strategy to ensure that its benefit obligations are met.

The essential

Pension funds make promises to their participants by guaranteeing them a certain level of retirement income in the future. That means they have to be relatively risk-aware, but also get enough returns to cover those guarantees. Fixed-income securities therefore tend to make up a large portion of retirement portfolios, along with blue-chip stocks. Increasingly, pension funds have sought additional yield elsewhere in real estate and alternative asset classes, although these items still remain relatively small portions of their portfolios.