Pensions take alternative path

Pension funds, which have seen their funding levels fall while stock markets have been in decline, are increasing their allocations to alternative asset classes.

Global equity markets have been hit by the ongoing economic uncertainty and weakness in European bank shares. And for Canadian pension plans, equities were the worst performing asset class in the quarter ending September 30 as the S&P TSX Composite lost 12%. As a result, Canadian pension assets fell 5.5% in the third quarter, putting year-to-date investment performance at -3.2%, as evidenced by figures published by RBC Dexia in October.

To counteract volatility in equities, pension funds continue to increase their exposure to alternatives. During 2010, allocations to alternatives increased by 16% to reach USD 889 billion, up from USD 762 billion in 2009, according to the Towers Watson/Financial Times Global Alternatives survey.

Alternative investments tend to provide enhanced risk-adjusted returns with lower volatility while also acting to mitigate loss—making them an excellent source of diversification in portfolios typically comprised of traditional investments. RBC Dexia’s pension quick poll released earlier this year revealed that inflation-sensitive assets such as infrastructure and real estate were the hedges of choice.

In a recent television interview on Canada’s Business News Network, RBC Dexia’s Scott MacDonald, Head, Pension, Insurance, Financial Institutions Products reiterated those findings and also noted that for plans with over a billion in assets, 46% of them expect to increase their investments in alternatives.

Many large Canadian institutional and government pension and endowments plans have been particularly active in real estate recently. For example, in September, the Canada Pension Plan Investment Board (CPPIB) announced a joint venture with General Growth Properties (GGP) to acquire Plaza Frontenac shopping mall in St. Louis Missouri—the heart of the American Midwest. Under the joint venture, GGP will own a 55% interest and CPPIB will own a 45% interest.

Many institutional investors have also added real assets as an inflation hedge in the form of real estate, infrastructure, timberland, agriculture and private energy, according to institutional investment researchers Callen Associates.

In light of ongoing volatility in equity markets, the pension fund performance may be predicated on increasing their activity in the alternatives space. The results of RBC Dexia’s pension quick poll indicated that for those respondents looking to add alternatives to their portfolios, 38% said they would look to real estate, 27% to infrastructure, 13% to both hedge funds and private equity and 9% other vehicles.

Is this the beginning of a long-term trend of pension funds targeting private assets such as real estate, private equity and infrastructure projects? If so, it could lead to a more balanced global diversification strategy for pension fund portfolios because of the continuous investment distribution and the lower volatility of private assets compared with other asset classes.

The challenge for pension funds will be to manage global acquisitions and daily investment management, taking into account language, tax, legal and cultural distinctions in global markets. This will require a strong commitment from pension funds and service providers in servicing these private assets and will lead to essential investments in knowledge and expertise to manage the various investment countries.

Dirk Holz
Senior Product Manager, Real Estate
Global Fund Products

RBC Dexia Investor Services Limited is a holding company that provides strategic direction and management oversight to its affiliates, including RBC Dexia Investor Services Trust, which operates in the U.K. through a branch authorized and regulated by the Financial Services Authority. All are licensed users of the RBC trademark (a registered trademark of Royal Bank of Canada) and Dexia trademark, and conduct their global custody and investment administration business under the RBC Dexia Investor Services brand name.

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