Pension funds diversify as rates fall
For decades, Dutch pension cash flowed to the place most likely to deliver steady and safe returns: government bonds.
No longer. Now the investor behind the Netherlands’ biggest pension fund is channelling retirement savings to a Belgian airport, a bicycle parking lot in Utrecht and toll roads in the US and Spain.
“Because of low interest rates, we have to cast our nets far and wide to search for returns,” says Thijs Knaap, senior investment strategist at APG Asset Management. “We increasingly invest more away from home. It’s where the growth is.”
In a world of stuttering expansion — where yields on US$14 trillion of bonds have turned negative — income is draining away on government debt that matches their longterm liabilities. So they’re getting creative to meet ever more-elusive return targets.
Knaap is at the vanguard of a move by the most conservative investors into areas far outside of their safety zone. They’re fuelling a boom in alternative assets such as private equity, property and infrastructure that PwC estimates will jump to US$21t in 2025 from US$10t in 2016.
“You’ve had a mad rush into these private assets,” says Elliot Hentov, head of policy research at State Street Global Advisors. “It’s a low-yield environment, everyone is piling in.” Even the Church of England is getting in on the act. Its pension board is scaling back stocks in favour of private debt including loans to small and medium-sized companies.
Central banks around the world delivered more than 700 interest-rate cuts over the past decade and spent trillions buying bonds. That helped to dodge a depression following the 2008 financial crisis, but growth has eased after a brief rebound, and most major economies undershoot policy makers’ inflation targets.
The US-China trade war and a slew of geopolitical risks are adding headwinds to growth, deepening the lower-for-longer trend for interest rates.
“Growth is sub-par, and declining,” says Jean-Jacques Barberis, head of institutional client coverage at Amundi. “We’re in a cycle that never seems to end, as monetary policy is being pushed and pushed to limits. Interest rates are going to stay low for a long time.”
Gains from bonds will be generally close to zero in the coming years, according to Amundi. It expects the Barclays Euro Aggregate index to lose 0.1 per cent over the next three years, before returning 0.2 per cent over the next five and 0.3 per cent over the successive decade. BlackRock
Because of low interest rates, we have to cast our nets far and wide to search for returns
reckons that a typical 60:40 strategy in which 60 per cent of assets are allocated to equities and 40 per cent to bonds will see average returns fall to 3.5 per cent over the next 10 years from 8.5 per cent in the past decade.
Contrast that with alternative assets. So far they’ve delivered returns above APG’s long-term target of 7-10 per cent. The firm earned 18.6 per cent on private-equity holdings since it started investing in the asset class in 2010. A BlackRock survey of clients overseeing US$7t of assets pub- lished in January found just over half planning to increase their allocation to alternative assets this year. “One of the biggest benefits of alternative assets is it’s uncorrelated return to the market,” says Anne Valentine Andrews at BlackRock Alternative Investors. “Illiquid assets such as infrastructure investment do not tend to experience the volatility of equities, which is valuable for many investors looking to diversify their portfolios.”
But the rapid dash to alternative assets by the stewards of retirement cash comes with risks, and it has caught the attention of regulators. They worry that in a downturn, funds would struggle to pull cash out of illiquid assets. While pension funds typically hold debt until maturity, it doesn’t mean they can’t be hurt by markto-market losses. American International Group, which had been the world’s largest insurer, was bailed out in 2009. Its losses on debt backed by defaulting subprime mortgages forced it to post collateral to banks and seek a US$85 billion government rescue.
“It’s all about timing the cycle,” says Hentov at State Street, who is presenting his research on private-debt investments at the IMF’s annual meetings this month. “You don’t want to be the big pensions fund invested in illiquid assets without a spreadable exit window.”
At PGIM Fixed Income, which oversees US$809b, senior portfolio manager Michael Collins says one of his biggest overweight positions is in structured debt such as collateralised loan obligations — securities pooling high-yield loans made to targets of leveraged buyouts. The Total Return Bond Fund he helps manage has put 20 per cent of its holdings into securitised debt and outperformed 95 per cent of peers over the past year, according to Bloomberg data.
Knaap at APG says buying illiquid assets needs a big balance sheet — and a lot of homework.
That might involving going to India to check out the leaky roof of an apartment building, for example, a “totally different” kind of due diligence than what you’d undertake to buy government bonds.
“You just can’t buy a portfolio of houses from one day to another, in contrast to bonds,” Knaap says. “It’s really labour-intensive.”
Thijs Knaap, APG Asset Management