Research firm Cerulli Associates has found that close to 70 per cent of European pensions plan to increase allocations to various alternative investment classes, principally infrastructure, in their search for diversification.
The institutions realise that the yields from their core holdings are inadequate and that markets for some mainstream assets are expensive. However, Cerulli warns that alternative managers still face myriad challenges winning new institutional business.
The firm found that some pensions are co-investing directly, thereby largely bypassing asset managers in some lucrative asset classes. “In addition, Europe's insurers must weigh up the value of alternatives in light of proposed high capital charges under Solvency II, and recent returns from some alternatives classes that seem at best mediocre.”
The reporting rigors insurers will face under Solvency ll are an additional pressure on alternative managers that insurers select, making full transparency and regular data updates essential services these days for all managers to make headway with European insurers.
Another issue is the fees for alternative strategies which may deter some institutions from allocating, but European pensions tell Cerulli that charges only rank mid-pack in the list of alternative fund attributes they examine. Risk management is more important.
"Pre-crisis, being 'alternative' often denoted a willingness in a manager to take risks trying new things – hedge funds making illiquid investments using side pockets, for example," says David Walker, director at Cerulli and lead author of the report. "That was then, but now, 'alternative' for an institution mainly means a manager generating returns while controlling risk. Managers should explain to Europe's institutions what they are good at, what they will not do, and stick to it," he added.
The hunger for non-mainstream assets is driven partly by a realisation by institutions that prevailing yields on core debt holdings alone will not generate the returns they need to honor their own promises to customers.
Laura D'Ippolito, senior analyst at Cerulli, notes: "The hunt for yield is not limited to the alternatives space. European institutions are also looking for further diversification within their fixed-income investments, and are considering strategies such as emerging market debt, bank loans, and credit."