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Alternative investments ‘the new black’ for global pension funds

Diversification is the new black.

Diversification is the new black. Photo: Getty

Collapsing bond yields are pushing superannuation funds to put more money into alternative investment classes across the globe, according to PriceWaterhouseCoopers’ latest global pension fund survey.

Alternatives have grown dramatically as a portfolio segment in recent years. The global average in that asset class rose from 19 per cent in 2009 to 26 per cent in 2014, the report found.

For Australian funds the figure was 22 per cent with a growing focus on international opportunities particularly in the US and UK markets.

The move to alternatives

The move to alternatives

Equities have shrunk in asset allocation, accounting for only 28 per cent of allocations in 2014 compared to 38 per cent in 2009. In Australia equity exposures tend to be larger, at around 45 per cent across the super sector. The assets PwC classes as alternatives include private equity, real estate, infrastructure and hedge funds.

The move towards alternatives has been largely driven by collapsing bond yields and their damaging effects on pension fund returns. Quoting the example of the giant Californian public sector fund pension fund CalPERS, the report says that to achieve its benchmark of an 8.8 per cent return in 1992, when the US 30 year bond rate was of 7.7 per cent demanded an outperformance of only 1.1 per cent.

By 2012 when rates were 2.9 per cent the outperformance on the bond rate was 4.6 per centage points despite the return target being cut to 7.5 per cent. The rate is now 3.13 per cent, meaning an outperformance of 4.37 per centage points is necessary.

“To succeed in today’s dynamic and precarious market, pension funds will have to strike the right balance…They will have to weigh traditional strategies against alternative ones, and consider the benefits of internal management over external management,” the report says.

One outcome of this move to more boutique investment options appears to be a greater reliance on in-house portfolio management. The trend is making itself felt in Australia but local funds are lagging behind their international counterparts in this area.

Australian super funds have an average of 18 in-house portfolio managers, well below the global average of 51. Canada’s pension system leads in this regard with an average of 92 per fund.

Overall there is a move to reliance on in-house investing across the globe over the last two years, PwC figures show. Survey respondents say the move is driven by better value for money in in-house teams better alignment between fund and investment team aims.

The move in-house

The move in-house

“In-house directly managed assets provide for greater control and flexibility; it’s also cheaper than external,” an Australian participant said.

Another Australian respondent said insourcing includes a focus on “skills and capability, as well as cultural alignment.”

The PwC study, which looked at seven Australian super funds and 35 pension funds globally, also said Australia has the lowest allocation of in-sourced investment professionals with a CFA (an international investment qualification).

The popularity of diversification is spreading beyond asset classes into geographical locations as well. In 2008 pension funds covered in the survey had 25 per cent of their investments in foreign assets. But buy 2014 this had jumped to 31 per cent.

Australia is mid-level for foreign investment

Australia is mid-level for foreign investment

Australia sits in the middle of  the overseas investment league tables. All the countries with higher exposure to foreign investment than Australia, other than Japan and Italy, are small or less developed economies where diversification is difficult to achieve.

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