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The return of volatility in equity markets since the end of 2018 sounded the alarm for institutional investors reassessing their asset allocations. With corporate borrowing at a record high and western equity market indices edging down from their recent peaks, investors are considering whether they have reached the end of the current economic market cycle.
At the end of March 2019, the yield spread between three month and 10 year Treasuries fell below zero for the first time in more than a decade, which Bloomberg labelled “the most significant inversion yet” in terms of indicating of an imminent economic downturn.
Given the repeated warnings from market economists, pension schemes are looking to lock in their returns from the past decade, weighing up the potential that exists in allocations to multi-asset investment strategies.
A survey of consultants’ asset allocation expectations within Research in Finance’s 2018 UK Institutional Market Study, found that 44% of respondents expected allocations to multi-asset strategies to increase in 2019, compared to just 9% who expect them to fall.
Matthew Towsey, principal and head of liquid alternatives at Aon, explains that investors are now reviewing their portfolios following the rapid rise in equity markets over the past 10 years.
“The increase in allocation to the multi-asset space is off of the back of what happened in 2018,” he said in an interview. “Prior to 2018, we had seen a steady rise in equity markets and investors were happy, but heightened volatility in equities, from December, led people to reassess their portfolios.”
Consultant responses to the 2018 UK Institutional Market Study suggested that allocations to multi-asset and absolute return strategies would be two of four asset classes likely to see significant increases in allocations in 2019, alongside infrastructure and liability driven investment strategies.
Throughout 2018, a range of economic indicators prompted a rethink in investment allocations. The rise in Italian bond yields in May, volatility in from events in Turkey and Argentina over the summer, and choppy western equity markets at the end of the year, all fed into assessments.
Investor concerns have since shifted to the prospect of slowing western economies and weaker international growth. Emerging markets are expected to play a bigger part on the global economic direction, with Chinese monetary policy, for example, being revised to stimulate growth.
“The rise in interest in multi-asset allocations is a response to 2018,” Towsey explains. “Whether it is hedge funds, alternative risk premia, absolute return bond funds, investors are seeking strategies that have little or no correlations.”
The hunt to find multi-asset strategies that have unique characteristics, however, can be a tricky business, so trustees are employing consultants to discover strategies which look like they will deliver something unique.
Typically, consultants like unusual research or investment processes, according to Towsey, preferring investment firms which are employee-owned, or where fund manager remuneration is linked to fund outperformance.
Defined contribution pension schemes are preparing to increase their allocations to illiquid investments ahead of a highly-anticipated regulatory announcement due in the second quarter of 2019.
The Financial Conduct Authority is planning to relax rules that currently restrict the amount of returns that pension schemes can generate from illiquid assets. It follows a separate Department for Work and Pensions’ consultation on illiquid assets and the development of scale in DC schemes.
The DWP report noted that “by investing almost wholly in highly liquid investments such as publicly-listed equity and debt, beneficiaries can miss out on the illiquidity premium which results from being invested for the long-term.”
Given this recognition that illiquids are indeed suitable for DC pension schemes, fund groups are anticipating inflows into real estate, private debt, infrastructure and venture capital strategies, as pension trustees respond to the changing regulatory guidance.
“Illiquid assets are definitely something that trustees are looking at,” Jayna Bhullar, an investment consultant at Quantum Advisory, told Research in Finance.
“Pension schemes are in a really good place because they have a long-term time horizon, which means they can ride out difficult markets.”
According to Research in Finance’s 2018 UK Institutional Market Study, 45% of consultants predict that pension funds will increase their allocations to infrastructure assets in 2019, while 43% said pension funds would increase allocations to direct lending. One in five were expected an increase in allocations to property.
Quantum’s Bhullar agrees that these illiquid asset classes look appealing, particularly for defined contribution pension schemes, but stresses that smaller schemes are likely to require some assistance prior to making their initial allocations.
“It is about trustee knowledge and understanding,” she explains. “It is important that members understand the investments.
“Some strategies are able to put up gates in the event of extreme liquidity events, so there may be instances where they are unable to access their capital as quickly.”
Bhullar’s concerns were echoed in a recent Pensions Policy Institute paper which stressed that an “information gap” exists for schemes that remain unaware of the benefits of investing in illiquid strategies.
For asset managers, there could also be another hurdle. Smaller DC schemes often use platforms that refuse to accept funds that don’t offer daily dealing as their systems are designed to update with daily pricing. To navigate these challenges, trustees may opt to employ a fiduciary manager.
Despite these considerations, Bhullar explains that there are a wide variety of fund providers in the market for those keen to get exposure.
Macquarie, IFM and Partners Group were among those to poll well in the Research in Finance’s 2018 UK Institutional Market Study when it came to infrastructure debt strategies, while Partners Group, BlackRock and Blackstone were commonly recognised for their private equity strategies.
“We predominantly use Partners Group, but there are several other good managers. BlackRock are quite prevalent in this market.”
* Those seeking to learn more about institutional investment attitudes towards illiquid asset allocations, with views from pension schemes, trustees and consultants, can find out more in the 86-page study, available here.