The $47trn pension market and how it approaches alternatives

Global pension funds' appetites for private markets has risen 17 percentage points over the past two decades, according to Willis Towers Watson.

The world’s largest pensions have made a significant shift in alternatives at the expense of equities and bonds over the past two decades and with it come the evolution of their organisations and investment strategies.

According to Willis Towers Watson’s Global Pension Assets Study 2020, which covers 22 major pension markets totalling $46.7 trillion in pension assets, there are three major trends in how these organisations approach alternatives.

Alternatives becomes a major asset class

Pension funds’ allocation to alternatives – private equity, real estate and infrastructure – rose 17 percentage points to 23 percent in 2019, compared with just 6 percent in 1999. Investors also continue to look for innovative ways to evolve their mandates to “better manage the agency, measurement, integration and complexity challenges involved with private markets”, the report noted.

From shifting geographic focus and opening offices in Asia-Pacific and Europe, to ramping up co-investments, pensions funds have continued to seek out alternatives in a variety of ways. The $30 billion Texas Municipal Retirement System, which has a roughly 20 percent allocation to alternatives, is building out a five-year roadmap for investing in Europe that includes backing up to 10 emerging GPs, as Private Equity International reported last week. Canadian pension funds, meanwhile, are putting down roots abroad: Ontario Municipal Employees Retirement System set up an outpost in London last year to tap disruptive technology companies in Europe, while Canada Pension Plan Investment Board is considering opening an office in China, as it looks to grow its China portfolio to C$150 billion ($113 billion; €103 billion) by 2030.

In-house investment teams are favoured over advisors

Larger pension funds, particularly those with more than $25 billion in assets, are building larger internal teams and depend less on outside organisations.

“Besides strong growth in assets last year, there was a noticeable pick-up in the decade-long trend of funds developing stronger strategies around their people,” Marisa Hall, co-head of the Willis Towers Watson’s Thinking Ahead Institute, said in a statement accompanying the report.

The bulking up of in-house investment teams has led to “stronger chief executive officer and chief investment officer roles” and more role specialisations in private market assets. Another growth area is the outsourced CIO model, which is often used by resource-constrained asset owners for a particular asset class and not for the whole portfolio.

Pursuit of purpose is a must

Sustainability is an area that continues to grow in importance among pensions funds and will result in a significant reallocation of capital over the next decade, particularly reflecting the climate change theme, according to the study.

Pensions in recent years have made adjustments in their portfolios. Last year the investment committee of the California State Teachers’ Retirement System, the US’s second-largest public pension fund with an approximately $20 billion PE portfolio, approved policy on carbon pricing consistent with UN’s Paris Agreement on climate change. CalSTRS began implementing a low-carbon transition plan which will guide the pension in managing climate-related risk and identifying investment opportunities across asset classes.

In the UK, the £2.5 billion ($3.3 billion; €3 billion) Oxfordshire Pension Fund is formulating a climate change policy which will be formally adopted in June. The £30 billion local government pension pool Brunel Pension Partnership also plans to release its own climate policy early this year.

The trend is set to continue – almost three in five European and Asia-Pacific investors plan to modify their private equity portfolios in the next five years to combat climate change, according to Coller Capital’s latest Global Private Equity Barometer.