Pension funds seek ways to meet retirement challenge

State Street’s research found that institutional investors are turning to asset pooling, direct investing and allocating to alternative assets to address their asset liability challenge.

Pension funds are pooling their resources either within their respective organisations or with external entities to build scale, according to George Sullivan, executive vice president and global head of State Street Corporation’s alternative investment solutions group.

Sullivan said asset pooling is happening both within one pension system and externally among different systems to increase efficiency and as a response to cost-cutting pressures. By joining forces, limited partners can share fixed costs through synergies and grow in scale to gain attractiveness among fund managers, he said.

“There’s such a tremendous advantage of having scale, in any business,” Sullivan told Private Equity International. “It helps to control cost and give you purchasing power.”

State Street’s recent research called Pensions with Purpose: Meeting the Retirement Challenge found that six of 10 LPs feel the pressure to reduce costs and 80 percent of LPs plan on merging retirement plans “to boost efficiency and oversight.” The study said such mergers will allow LPs to access previously inaccessible assets, adopt standardised governance tactics and make more room for efficiency through better use of technology.

The Sixth Swedish National Pension Fund, AP Fondon 6, spokesman Ulf Lindqvist told PEI in January that the fund still believes in the benefits of asset consolidation, despite the government’s decision in December to cancel pension system reform. It had plans to merge its assets with AP2 to realise scale.

“You can lower costs and get better access to better deals and more interesting investment opportunities if you have enough financial weight,” Lindqvist said.

In October, the UK chancellor George Osborne announced that it will pool its 89 existing local authority pension funds into six British Wealth Funds with combined assets of more than £25 billion ($38 billion; €33.8 billion). Osborne said the initiative would save “millions of pounds every year in costs and fees.”

The State Street study also indicated that more US public pension plans are seeking direct investing in alternative assets, particularly in private equity and real estate. It said the California Public Employees’ Retirement System has “moved in this direction,” followed by smaller LPs, and cited the large Canadian pension plans’ long-time practice of such a strategy.

Sullivan noted that more institutional investors are allocating their capital to private equity primarily due to its outperforming returns compared with other asset classes, thanks to the lock-up feature of the funds.

“When capital is locked it matches the duration of the capital with maturation of the investments to realise the full value,” he said. “There isn’t a liquidity event where investor can make the decision to take money out of the fund. Therefore, it allows the investor to realise the benefits [of long-term investing].”

However, he pointed to some of the survey results that showed how investors need to be doing more. A whopping 92 percent of funds plan on upgrading their governance model in the next year, and 45 percent are seeking to increase training and education opportunities for board members. Furthermore, funds are ramping up their internal specialist talent, the study said, with 48 percent doing so for the internal risk teams and 45 percent for investment teams in the next three years.

“That suggests more needs to be done around talent and training and governance of plans, Sullivan said. “But I’d go even further to say, because these are private investments, risks around them are not as easy to determine as risk around an equity strategy. So transparency into the terms of the mandates, risk attributes of the strategies and pricing of portfolio companies are challenges that investors face.”

Still, investors are driven towards private equity because of the returns, with most of them either keeping or increasing their allocation to the asset class, he said.

“With the asset liability challenge that institutional investors have, their desire to overcome that challenge through private equity is substantial,” he said.

State Street collected responses from 400 pension professionals in 20 countries throughout a two-month period.