Natural Resource Fund Assets Grow by $48 Billion in Six Months

Commodities worldwide are in high demand based on a significant increase in assets held by unlisted natural resources funds. As of June 2016, assets in these funds reached $455 billion, while the industry grew by $48 billion in six months. All old assets under management in this fund category have tripled in size since 2008, according to a new report by Preqin.

In its new 2017 Global Natural Resources reportthe data, analysis and intelligence
services company found that unlisted natural resources assets grew by 12% in the first half of 2016, following two successive years in which the industry expanded by 10%.

Most of this asset growth was in “vintage” funds (funds started before 2009, according to Preqin) that hold a significant proportion of industry assets. Funds with a 2009 vintage or older hold $89 billion in total assets, almost one-fifth of the total industry.

Funds launched post-2009 have significant amounts of “dry powder” (capital yet to be invested) to invest. This may help explain why 2014 vintage funds alone account for $49 billion, almost as much as the $50 billion held by 2016-vintage vehicles. North America-focused funds account for $328 billion, or 72% of total global assets. This AUM total dwarfs those held by funds focused on Europe ($52 billion), Asia ($23 billion) or other regions ($53 billion). Similarly, energy-focused funds hold $362 billion in total assets and account for 79% of the industry AUM. Diversified natural resources funds account for 7% of AUM, while agriculture (5%), mining (4%), timberland (4%) and water (0.3%) funds are much smaller.

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As a category, energy-focused funds are the fastest-growing sector of the unlisted natural resources industry. The AUM of energy funds grew by 18% in the first half of 2016, compared to 12% for agriculture funds and 6% for mining funds. Diversified natural resources funds actually saw assets decrease by 10% in the same period.

According to Tom Carr, Preqin’s Head of Real Assets Products, “the unlisted natural resources industry added almost $50 billion in combined assets in the first six months of 2016 alone. These funds are continuing to grow and the pace of growth for the industry is actually accelerating. This whole sector has seen double-digit annual increases for over a decade. At this pace, we may see the industry exceed half a trillion dollars in AUM by the end of 2017.”

Carr noted that within the asset class, the balance of assets remains heavily weighted towards energy funds and funds investing in North America. Although agriculture- and mining-focused funds have seen steady growth, they remain dwarfed by the energy sector. “Still, all primary natural resources sectors have seen consistent growth, and the asset class as a whole continues to emerge as an important part of the alternatives industry,” Carr said.

Performance Remains an Issue

The study found that 54% of respondents to Preqin’s latest survey of institutional investors said their investments in natural resources “fell short of their expectations” in 2016 as more investors were dissatisfied with their natural resources investments than were dissatisfied with their portfolios of any of the other private capital asset classes. The report said this is “a significant worry for managers” seeking to raise capital, but investors remain optimistic. The study found that investor interest in the asset class is improving, with 80% of investors considering the asset class positively or neutrally, compared with 67% at year-end 2015.

Yet despite performance concerns, investors remain bullish on the asset class entering into 2017, and 35% expect the asset class to perform better than it did in 2016, compared with 21% that believe it will perform worse.

The largest funds in the sector investing in North America are: the Riverstone Global Energy and Power Fund VI (AUM $5 billion); North America Global North Haven Infrastructure Partners II (AUM $3.6 billion); Global Stonepeak Infrastructure Partners II (AUM $3.5 billion); Water North America Carlyle Energy Mezzanine Opportunities Fund II (AUM $2.8 billion); and the Global AMP Capital Global Infrastructure Fund (AUM $2.4 billion).

Investors and Managers Neutral on Terms

As part of their survey, the study found that the majority (63%) of investors surveyed have seen no changes in prevailing fund terms over the last year, but 27% of institutions saw a change in fund terms that favor investors, compared with 9% that have witnessed changes in favor of fund managers. One reason for this change in favor of investors may be due to an increasingly competitive fundraising environment, the study suggested.

This may help explain why investors are seeing changes in management fees, how performance fees are charged, transparency and higher commitments from fund managers. Each mentioned by more than half of surveyed investors as areas in which they would like to see improvement. However, 43% of institutions reported changes to management fees and transparency in the past 12 months, indicating that fund managers have taken action to reformat their fund’s term offerings.

By Chuck Epstein

Faced with tepid returns and a challenging outlook, the nation’s two largest pension funds have lowered their discount rates. It’s a move that could put California taxpayers on the hook for billions more in pension contributions, but the shift also leaves the two big pension funds in better health, according to a new analysis by S&P Global Ratings.

The California Public Employees’ Retirement System (CalPERS) voted in late December to gradually lower its discount rate to 7% by 2018 from 7.5% in 2015. In February, the California State Teachers’ Retirement System (CalSTRS) decided to follow suit, although it’s moving slightly faster. CalSTRS will cut its discount rate from 7.5% to 7% by 2017.

“It’s quite a big deal,” said Todd Tauzer, a credit analyst at S&P Global Ratings and lead author of a new report about the challenges facing the California systems.

Tauzer sees the plans’ moves to cut their discount rates as painful in the short run but healthy in the longer term. By lowering assumptions about discount rates, the pension funds are setting the stage for heftier employer contributions.

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Tauzer projects that lower discount rates mean a decade from now, the state of California will be required to boost annual contributions to CalPERS and CalSTRS by $2 billion each.

“We believe that notwithstanding the near-term budget pressure that the reduced discount rates imply, they are constructive for stabilizing these pension systems in the long term,” Tauzer wrote in his report.

CalPERS had a market value of nearly $310 billion as of March 14. CalSTRS held $202 billion as of Feb. 28.

Their assumptions about returns had been “arguably unrealistic,” Tauzer wrote.

Tauzer sees a variety of challenges for the California pension systems. One is low inflation, a generally desirable economic condition but one that hampers pension funds’ returns. While US inflation averaged 4% from 1970 to 2016, the inflation rate hasn’t topped 4% since the early 1990s.

Low interest rates are a related challenge. While the Federal Reserve on March 15 raised rates and is expected to do so twice more in 2017, rates remain so low that even a continued rise is unlikely to significantly boost pension fund returns, Tauzer said.

A stock market correction would pose another challenge to the big California funds.And there’s also the one-two punch of a dwindling ratio of active workers to retirees and an aging beneficiary population.

“Plans with more retirees have more assets relative to their active payroll, leaving them vulnerable in that a single market downturn could push unfunded liabilities into a very painful or virtually unrecoverable state,” Tauzer wrote.

The CalPERS board of administration also terminated its contract with the East San Gabriel Valley Human Services consortium after it failed to pay $406,345 to fund its pension plan. As a result, pension benefits will be reduced by approximately 63% for 191 members, and by 24% for six members hired after pension reform went into effect in 2013. The cuts are effective July 1.

“The Board was forced to make this painful decision after East San Gabriel Valley failed to stand by its contractual obligations despite repeated and numerous attempts by CalPERS to avoid this terrible situation,” said Rob Feckner, president of the CalPERS Board. “Cutting benefits to retirees is truly the last step we want to take, but our employers must uphold their obligations and keep the promises that they made to their employees. We have a fiduciary responsibility to protect the long-term future of all beneficiaries and the fund.”

East San Gabriel Valley is a Joint Powers Authority consortium formed in 1979 by the cities of West Covina, Covina, Azusa, and Glendora to primarily provide employment and training services to local residents and inmates incarcerated by the Los Angeles County Sheriff’s Department.

By Jeff Ostrowski and Michael Katz