Pensions diversify away from equities

Towers Watson recently released its annual Global Alternatives Survey in conjunction with the Financial Times of London, England. The survey, in its ninth year, gathered information on alternatives products offered to investors, including pension funds, sovereign wealth funds (SWFs) and insurance companies, as at the end of 2011.

For purposes of the survey, alternatives included private equity and hedge funds (both direct and fund of funds), real estate, infrastructure and commodities.

Almost 500 alternatives managers were surveyed, with total alternatives assets under management at nearly $5 trillion. Interestingly, the top 100 alternatives managers accounted for more than $3 trillion, up nearly 8% from the previous year. The percentage of these managers’ assets sourced from pension funds increased by 16%, lending credence to the perception that pension funds have continued to diversify away from equities.

On average, 35% of alternative assets were invested in real estate, 31% in private equity (9% in fund of funds, 22% in direct funds), 27% in hedge funds (6% in fund of funds, 21% in direct funds), 4% in infrastructure and 3% in commodities. As I noted in a previous article, Canadian investors have been focused on real estate and infrastructure, with fewer assets allocated to private equity and only a small percentage to hedge funds and commodities.

While the top 100 alternatives managers remain reliant on pension funds (74% of their assets derive from pension funds), other institutional investors have significant assets invested with them as well. Insurance companies represent 15% of the top 100 managers’ assets, SWFs represent 7% and foundations and endowments represent 4%. Insurance investors have tended to concentrate on real estate investing, with more than 50% of their alternative assets deployed there. Foundations and endowments have allocated a large proportion of their assets to private equity, while SWFs have focused on real estate and private equity.

Being large mattered more in real estate, where the top 100 alternatives managers accounted for nearly 80% of assets under management. Direct private equity also had a relatively high percentage (68%) of assets under management controlled by the top 100. Conversely, the top 100 managers accounted for only 45% of infrastructure assets and 43% of fund of hedge funds assets.

While pension funds have continued to increase their allocations to alternative assets, this has not always been so with the largest alternatives managers. Pension fund assets for the top 100 alternatives managers were $1.2 trillion at the end of 2011, or approximately 33%. Again, there are observed differences between alternatives categories. Pension funds accounted for 62% of the top 50 fund of private equity funds managers’ assets and almost 62% of the top 20 infrastructure managers’ assets. Pension funds were less important to the top 20 commodities managers, representing not quite 27% of their assets. Hedge funds, both direct and fund of funds, were also less reliant on pension funds, which accounted for 36% and 38% of the top 50 managers’ assets, respectively.

The survey also looked at the geographical distribution of the assets under management. Not surprisingly, North America accounted for nearly half of invested assets, though again, this differed by asset category. For commodity assets, 98% of these were invested in North America, compared with only 34% of infrastructure assets, not quite 60% of private equity assets and 43% of hedge fund assets. Europe accounted for a large share of infrastructure investment (45%) and real estate investment (39%). Asia-Pacific garnered 12% of alternatives investment, with Asian hedge funds having a higher-than-average allocation at 18%.

SWF investment patterns are interesting to observe as they differ from pension fund allocations. Pension funds have tended to favour private equity fund of funds and direct hedge funds. The opposite has been true for SWFs, which have allocated significantly more assets to direct private equity funds and hedge fund of funds. Overall, the percentage allocated to fund of hedge funds has been declining over the past few years, a direct result of greater institutional participation and a greater focus on fees, transparency and operational efficiencies.

While investor behaviour differs by investor type, it is clear that the percentage allocated to alternatives continues to increase. It goes without saying that these are complex asset categories that require significant oversight and monitoring. Despite the additional time and effort (and expense), it doesn’t appear that the trend away from equities is going to abate any time soon.