Public pension funds hold over $17tn in assets, putting them in the top echelon of power in the global investment landscape. Compared to sovereign funds at $8tn and central banks at $14tn, they are the largest set of institutions in the sovereign investment universe, according to data collected by OMFIF. But their importance extends beyond financial clout. They lie at the heart of global trends in demographics, geopolitics and technology.
The shift from traditional assets to alternatives is continuing at a steady pace; the average pension portfolio now holds over 13% of its assets in real estate, infrastructure and private equity. Fixed income makes up only 43% of total assets on a weighted average basis, while the median portfolio in this sample only holds a quarter of its assets in fixed income.
However, fixed income assets remain central to a handful of extremely large funds. Of the 13 largest funds, only four hold more than 95% of their total assets in government bonds. This has important implications for their future funding but also for sovereign debt markets, which are seeing a dramatic flow of new issuance in the wake of governments’ and corporations’ Covid-19 response efforts. Can these previously captive buyers continue their retreat from government and corporate bond markets, or are they too embroiled in real-economy funding to withdraw further from these low- and negative-yielding assets?
Alternatives have been a significant beneficiary of low returns in bond markets; allocations continue to rise, with some funds using their allocations to infrastructure in particular to promote their new sustainability agenda. Yet the opacity, illiquidity and reputational dangers inherent in private markets pose risks to pension funds seeking to carve out a broader understanding of fiduciary responsibility vis-à-vis their members.
The demanding scale of fee structures in alternatives has driven some funds to develop internal capacity to conduct deals, weaning themselves off external managers to foster in-house platforms instead. This has led them to establish new investment teams and open offices in far-flung regions, raising fresh questions about the geography of financial power.
Listed equities, too, have been able to provide significant growth, as investors have sought to ride the US bull market for as long as possible. By the end of 2019, public pensions’ listed equity allocation stood at 33% on a weighted average basis. Their allocations to this asset classes have allowed for significant influence on issues of stewardship and corporate governance, as Chapter 6 highlights. Yet equities are unpredictable; while they allowed for a sharp bounce-back from the initial Covid-19 shock in March, they have contributed to significant volatility in past investment returns, especially around December 2018.
This push into equity and alternatives is partly driven by a desire to meet actuarial targets for future funding. Public pensions’ funding status has been a cause for heated discussion, particularly amid the post-2008 financial crisis low interest rate environment. In part, this is because pension funds set target rates of return they are required to achieve in order to achieve actuarial long-term sustainability. This report demonstrates how these have failed to change over the past five years, with real return assumptions in fact rising, based on a sample of global public pensions.
The report sketches how pension funds have coped with the choice between diversifying into higher-return assets or facing future funding pressures. The search is on for an investment product that can both mimic the behaviour of fixed income and provide attractive returns.
This is an extract from Global Public Investor 2020. Click here to download the full version.