Pensions Seek to Reduce Equity and Bond Exposure, Favor Alts

(January 31, 2011) — Research has shown that pension funds and other institutional investors are backing out of traditional equity and bond allocations and increasingly favoring alternative asset classes.

On a global basis, in its fifth bi-annual Pension Funds Asset Allocation Survey compiled from studying 50 institutional investors representing nearly $205 billion of assets, financial services consultant firm bfinance noted that the findings from its recent study signals a shift in sentiment by pension funds, as they are seeking to diversify away from core asset classes and into property and alternatives, with infrastructure and private equity attracting the most popularity. In an interview with CFA Institute magazine, the world’s largest sovereign wealth fund, the Abu Dhabi Investment Authority (Adia), said it continues to focus on infrastructure assets for its long-term stable yields. Similarly, earlier this month, in an effort to locate stable long-term investment vehicles with decent yields, the Alberta Investment Management Corporation (AIMCo) agreed to buy a 50% stake in Autopista Central, a motorway in Santiago, Chile.

Bfinance said it expected infrastructure and private equity to increase 14% and 10% respectively over the past six months. According to the research, 29% of schemes plan to reduce their equity holdings in the next three years, while only 14% plan to increase their weighting. The research showed that a total of 12% of investors decreased their fixed-income allocation in the second half of last year, a move largely driven by tension in the bond market caused by Europe’s sovereign debt crisis.

“We observed some slight geographical differences, with American and British investors slightly more willing to invest or maintain their position in bonds than investors from continental Europe, which can be linked to the fact that continental European investors traditionally allocate more to bonds and maybe also to the fact that in the US, the QE2 program targets the longer part of the yield curve,” bfinance spokesman Emmanuel Léchère told aiCIO.

Furthermore, the survey indicated that more schemes have re-evaluated their investment managers over the last six months, as reviews of asset allocation and mandate expiry have become increasingly important reasons for investment manager changes.

In the US, pension systems are also looking to up their allocation to alternatives. According to a report by Cliffwater, public pension funds in the US are likely to allocate an additional $20 billion to hedge funds. The study by the alternative advisory firm found that nearly half of the pension funds surveyed invest only directly in hedge funds, while 33% invest solely through funds of hedge funds, and 18% allocate via a combination of both. The firm noted that it expects that persistent low bond yields and modest expected equity returns will likely drive pension systems to further increase their allocations to hedge funds. “Increased institutional familiarity with hedge funds should cause most new hedge fund investments to be direct rather than through fund-of-funds,” according to the report by Cliffwater.

The research, which measured hedge fund allocations for 96 state pension plans as of fiscal year-end 2010, found that on average, the pensions surveyed currently allocate 6.6% of total assets to hedge funds, compared with an average target allocation of 7.3%. The 96 state pension systems collectively invest $63 billion in hedge funds at fiscal end 2010, double the $28 billion invested in hedge funds in fiscal 2006, and over one-half — 52 out of 96 — of pensions invest in hedge funds, up from 21 systems in 2006.

This change in the US is also reflected in the UK, where the UK’s Universities Superannuation Scheme has decided to pump more money into emerging markets and hedge funds. Chief Investment Officer Roger Gray told Reuters that as the scheme moves away from equities, it will also invest at least 1.5%, or close to 500 million pounds, in hedge funds, with a longer-term target of 5%.