The sponsors of US pension schemes are looking to increase the diversification and reduce the correlation of assets in their portfolios by increasing their holdings of alternative investme
The sponsors of US pension schemes are looking to increase the diversification and reduce the correlation of assets in their portfolios by increasing their holdings of alternative investments such as hedge funds and private equity, according to a new report from consulting firm Greenwich Associates.
Over the past decade, US endowments and foundations have achieved impressive investment successes with portfolio strategies based largely on broadening application of the precepts of modern portfolio theory, the authors of the 2008 Greenwich Associates U.S. Asset Allocation Report say.
Their research indicates that US pension funds are following the example of endowments in a shake-up of their own portfolios. However, the report says, pension plan sponsors are not simply adopting endowment asset allocation models, but are integrating strategies that have worked well for endowments and foundations into a still-evolving approach to fund management that also includes strategies for closely matching plan assets to pension liabilities.
The report’s analysis of asset allocation trends among corporate and public pension funds, endowments and foundations indicates that working on the assumption that a diversified portfolio of low-correlated assets can achieve superior risk-adjusted returns, pension scheme sponsors are expanding their holdings of alternative investments, especially hedge funds and private equity.
They are also diversifying their portfolios by increasing their exposure to international investments, particularly foreign equities, which sponsors expect to outperform domestic stocks by a wide margin. And they are exploring ways to minimise their funds’ exposure to interest rate risk and related portfolio volatility risk through techniques such as asset-liability matching and liability-driven investment strategies.
‘What we’re seeing is a fundamental shift in how institutions manage their assets,’ says Greenwich consultant Dev Clifford. ‘Although the new approach is still a work in progress, institutions seem to believe that new financial instruments and strategies will allow them to optimise investment performance while also ensuring their ability to fund future liabilities.’
Every year, the firm asks all the institutions participating in its US Investment Management research programme, including pension funds, endowments and foundations, whether they expect to make any significant changes to their asset mix within the next three years.
Since 2005, some 38 per cent of the funds have said they do plan significant changes, suggesting that possibly as many as half of all US institutional investors are considering, planning or in the midst of a major portfolio reallocation. Various significant shifts last year indicate that this restructuring may already be well underway.
Institutions increased the share of assets allocated to international stocks to 17.9 per cent of total assets in 2007 from 15.2 per cent the previous year. The current allocation is one-third higher than four years ago. Meanwhile allocations to US equities fell to 41.7 per cent from 44.8 per cent in 2006, and US fixed-income allocations declined from 22.4 to 21.4 per cent, continuing a trend dating back at least five years.
While allocations to private equity and equity real estate declined slightly among all US institutions, allocations remain substantial among certain types of investors, such as public pension schemes, which allocated 5.6 per cent of their assets to equity real estate, while endowments devoted 8.3 per cent of assets to private equity.
Hedge fund allocations, meanwhile, continue to climb. Institutions allocated on average 2.6 per cent of total assets to hedge funds last year, up from 2.2 per cent in 2006, 1.9 per cent in 2005, and 1.6 per cent in 2004. Allocations among active users of hedge funds are much higher.
The Greenwich research results suggest that many of these trends may intensify this year. A quarter of all US funds interviewed expect to reduce significantly allocations to active US common stocks within the next three years, while only 3 per cent plan to increase these allocations. Meanwhile, 13 percent of institutions plan a major increase in allocation to active international equities and another 10 per cent expect to make a significant increase.
Nearly a third of institutions plan to increase significantly their allocations to private equity, 23 per cent expect to increase hedge fund allocations and 21 per cent plan to boost equity real estate allocations. In each case, less than 2 per cent of institutions plan to cut their allocations.
‘Our research reveals that diversification remains the dominant trend in institutional portfolios, and in general is taking two forms – a shift of assets into alternative investments and allocation adjustments that reduce the level of ‘home bias’ and change portfolio composition to better reflect global market capitalisation,’ says Greenwich consultant William Wechsler.
Greenwich Associates is an international research-based consulting firm in institutional financial services, specialising in providing benchmark information on best practices and market intelligence on overall trends. Based in Greenwich, Connecticut, with offices in London, Toronto, Tokyo and Singapore, the firm offers more than 100 research-based consulting programmes to more than 250 global financial services clients.
