Smart Money Trends in Private Investment | The Move Away From the Traditional “Balanced” Portfolio
By: Cora Pettipas
It is always interesting to look at smart money trends, particularly investment developments in pension plans. One noticeable movement across Canadian pension plans is the growth of exposure into private placements and private equity as part of a new portfolio asset allocation standard. Pension plans in Canada currently manage 1.31 trillion in funds earmarked for Canadians’ retirement, the lion’s share being for public service employees. Since the global financial crisis in 2008, Canadian pension plans have been striving to diversify into non-market correlated assets by investing in private companies that can achieve a long term rate of return needed for the pension plans to fulfill their payment obligations.
Below is a chart of major pension plans and their current holdings, as well as their corresponding returns, taken from their 2011 annual reviews. Exempt market assets can be denoted under different equity classes, so all relevant asset classes are displayed. It is recommended that you read the annual reports for more details on segmentation and rate of return assumptions, most are very well written.
Pension funds are moving away from the traditional balanced fund: the 60% equity, 40% fixed income portfolio, and modernizing their asset allocations with alternative investments. “Let’s examine what balanced fund managers have done over the last 10 years and compare that to our total fund performance. Balanced fund managers invest primarily in publicly traded asset classes, very similar to what our policy was 10 years ago. Over the last 10 years the Mercer balance fund survey puts the median balanced fund manager return on a gross basis (before costs) at 7.0% versus a 10-year policy return for LAPP of 8.0%. In fact the 8.0% return would have put the LAPP fund at the top end of the Mercer survey. Our actual return over the 10 year period was 7.8% on a net basis which suggests that most of the gain came from the differences in asset mix.” States Meryl Whittaker, CEO of LAPP Corp, in her investment commentary.
Pension funds are changing their allocations to enhance their risk adjusted yield. “Our strategy to shift capital from public to private markets is working in accordance with our Strategic Plan’s goal to achieve diversification in this asset mix.” States Michael Nobrega, President & CEO OMERS 2011 in their Annual Report. Another large pension plan, OTTrust, stated in their 2011 annual report that the findings of their asset liability study has motivated them to decrease their target public equity holdings by 16%, increase their private equity targets by 5% and increase their real estate holdings by 10%. “We use alternative investments to capitalize on market inefficiencies and earn returns that are uncorrelated to other asset classes — thereby delivering true diversification.” States Ronald Mock, for the Ontario Teachers Pension Plan.
Pension plans are using private investments to diversify, increase yield, and to reduce risk. They are achieving this by creating true diversification and neutralizing market risk with non correlated assets of private investments. It is interesting to see how pension plans are being truly innovative with their modeling and portfolio strategies, and are incorporating private investments into their asset allocation models to decrease overall portfolio risk, just like many DRs in the exempt market are doing for their clients on a product by product basis.