A snapshot of the current investment climate reveals a world defined by low interest rates, artificial asset inflation and global economic uncertainty. While the U.S. Federal Reserve’s quantitative easing may have calmed global markets, it has also forced pension plan sponsors into an untenable position: accepting more risk and less reward for their fixed-income investments. In the current economic climate, private equity can offer a compelling risk/return profile that should be considered as an alternative in a pension portfolio. Private-equity managers look for specific secular or cyclical trends that can lead to opportunity.
There are five areas that we find interesting in the present market:
• Deleveraging of the banking system – As the banks are shrinking their balance sheets and getting out of certain assets and asset categories, we think private equity is in a very good position to step in and fill the void, particularly with respect to distressed banks and mortgage servicing.
• Energy markets – Over the past five to six years, shale (natural gas) has revolutionized domestic energy markets. However, the energy segment is extremely capital intensive and requires corporate agility. We believe private equity has a unique opportunity to create attractive investments in this space.
• Transportation – In the shipping industry, no net new capacity is coming online in 2014, but growth rates (albeit lower) are still positive. We see the supply/demand equilibrium coming back to a better place and presenting opportunities to deploy capital in this sector.
• Heavy building materials – With U.S. infrastructure expenditures at a 25-year low in terms of percentage of GDP, there is clearly going to be some catch-up spending necessary, and we see residential and commercial construction picking up. Spending will come in the form of cement, aggregate, concrete and asphalt, not only for infrastructure but also for residential and commercial construction.
• Europe – Banking institutions in Europe (especially Spain, Italy and Greece) have a lot of work to do regarding their toxic assets. Private capital can come in and be the lender of last resort for small and medium-size enterprises that lack access to working capital.
Pension plan allocations to private equity are increasing as more plan sponsors look to alternatives for diversification and long-term performance. With Treasury yields expected to remain at historic lows well into 2014, private equity can offer an attractive risk/return profile and the ability for plan sponsors to diversify, generating non-correlated returns to other asset classes.
Stephen Toy is managing director, WL Ross & Co. LLC (affiliate of Invesco)