Pension Funds Seek Riskier, Illiquid Bets

Mar 16 2015 | 9:50am ET

By Carolyn Cohn (Reuters) - British pension funds are coping with low bond yields and high share prices by seeking riskier investments, in a hunt for the returns they need to meet their obligations to pensioners.

Collectively managing at least 2.5 trillion pounds ($3.69 trillion), pension funds are reeling from six years of money-printing by central banks globally, which has depressed yields so much that some bonds even cost investors money to hold them.

Speakers and delegates at a National Association of Pension Funds conference this week warned that pension fund investment into more volatile equities is fuelling a stock market bubble, where share valuations have risen to record levels even though corporate earnings have been disappointing.

"The other side of the low interest rates (environment) is we are now seeing enormous risk-taking and the risk of bubbles," Steven Maijoor, chairman of the European Securities and Markets Authority told the conference.

More and more schemes are being tempted to look for alternative assets to invest in, which are often more risky and illiquid, including infrastructure bonds, direct corporate loans, catastrophe bonds and emerging market debt.

Conference attendees were even discussing frontier debt, the riskiest of emerging market bonds.

A typical pension fund would likely have around half of the growth assets portion of its portfolio in stocks, a quarter in real estate and the remaining quarter in other alternatives, such as hedge funds, infrastructure or direct lending, said John Walbaum, head of investment consulting at Hymans Robertson.

"In a world where bonds are yielding inflation minus 1 percent, if you can get something which yields a bit more than that, it's the way to go," said Chris Hitchen, chief executive of railway pension fund RPMI.

Record high stock markets are even making hedge funds, known for taking risks, nervous of high share valuations. Manny Roman, chief executive of Man Group <EMG.L>, the world's largest listed hedge fund, told the conference:

"Bubbles are complicated - they go up, it's very hard to predict if and when they burst. I would urge anyone to be very cautious."

Britain's FTSE 100 <.FTSE> flirted with record highs of 7,000 points earlier in March, while the U.S. Standard & Poor's 500 <.SPX> is just shy of its all-time high. In the UK, FTSE 100 firms, have so far on average missed full-year profit expectations by 1.1 percent, Thomson Reuters StarMine data showed.

Among more exotic investments, emerging market corporate debt with a triple-B investment grade rating offers a 100 basis point yield premium to euro zone corporate debt with the same credit rating, fund managers say.

UK property prices produced double-digit gains in 2014. But higher costs, as charged by hedge funds, can dent these returns. and so can an increase in the cost of regulatory capital needed to hold these investments.

There is also a greater chance that funds may not be able to sell these assets quickly if they need to, because of restrictions placed on banks following the financial crisis.

"On the corporate (debt) side, you have seen a drop of about 80 percent in liquidity since before the crisis, said Alain Kerneis, a managing director at BlackRock.

The number of dealers quoting prices in euro zone investment grade corporate bonds has dropped to 3 from 8-9 five years ago, fund managers said.

But they also said there were new pockets of liquidity, such as exchange-traded funds (ETFs), which were proving cheaper and more liquid than traditional equity index futures.

And provided pension funds are diverse in their asset allocation, they can cope with some illiquid assets because their investments are long-term.

"You just have to make sure you have enough liquid assets to make your payments," said Walbaum.


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