Over the past 15 years, we’ve seen Canadian institutional investors shift away from the traditional, familiar and comfortable asset mix consisting of only equities and fixed income, and increase their alternative allocations. This post, the first in a three-part series exploring this shift, will examine specific trends in asset allocation and the implications for asset managers.
While investors have previously shied away from real estate, infrastructure and private equity, these asset classes are increasingly making their way into portfolios – in quite noteworthy weights as well.
Let’s take a look at pension plans as an example. According to the Canadian Institutional Investment Network, alternative investments represented 26% of total pension assets in Canada at the end of 2014. A quarter portfolio weight doesn’t seem very extraordinary until you compare this number to the 13.3% representing alternative investments just five years previously in 2009.
Read: What should institutional investors expect from the real estate market in 2016?
It’s important to note that in the case of pension plans, total pension assets in Canada don’t tell the entire story. Plans with assets greater than $10 billion allocated 34% to alternatives in 2015, while small- and medium-sized plans allocated only 12% and 7.5%, respectively. As larger plans forge the path towards alternatives, a common belief among smaller plans is that, without the same amounts of capital available for investment, they suffer from economies of scale and are simply unable to follow suit.
However, this is a misconception. A smaller plan with the right asset mix and the right management of that mix (which is revisited below) can take advantage of the benefits provided by alternative investments. These benefits seek to provide lower volatility and stable income, which will be discussed in Part III of this series.
Read: Smaller pension plans starting to invest like big ones
Looking forward into the future, we expect the move towards alternative assets to continue. As the pressures that catalyzed this shift – such as volatility in equity markets and low interest rates – continue to play their part in the Canadian investment environment, we believe investors will continue to look for new solutions. Part II of this series will go into more detail about the pressures that contributed to this trend.
A change in asset allocation trends means that not only will investors need to adapt, but so will asset managers.
Perhaps the most apparent change for asset managers is the rising demand for more diversified products. Greenwich Associates surveyed 235 of the largest tax-exempt funds in Canada in 2015 and found that a little more than one-third (36%) of the funds expect to “significantly increase” allocations to infrastructure, a little less than one-third (31%) expect the same for real estate, and a little more than one-fifth (21%) said the same for private equity. This is indicative of the rising demand. As more investors learn about the potential benefits of allocating to alternatives, managers will need to provide the means to realize these benefits.
Read: Alternative assets taking on new prominence: survey
Another change has to do with capabilities and the services provided. As mentioned above, the right management is needed to help smaller plans realize the potential benefits of alternative investments.
Consider the following: a manager who can add alternatives into a traditional asset mix and then continuously meet liquidity and cash-flow needs, all while keeping the mix constant, is very valuable to a plan of any size – especially a small plan that hopes to avoid the complexity of keeping its own mix constant when multiple managers are responsible for different asset classes.
The second post in this series will look at some of the factors that led to this shift in asset allocation, including market conditions and demographic changes. The third and final post will consider both the benefits and challenges that come with alternative investments, namely liquidity as a challenge and how it can be mitigated.