Rock-bottom yields from government bonds and destabilising bouts of volatility in equity markets have pushed institutional investors to invest ever more money with alternative investment managers in the quest for higher returns.
According to research from Willis Towers Watson, the pension fund consultancy, total assets managed by the 100 largest alternative investment managers rose to $3.6tn at the start of the year, up 3 per cent on the previous year.
“The shift away from equities and bonds into alternatives has gained momentum among most institutional investors around the world,” says Luba Nikulina, global head of manager research at Willis Towers Watson.
Allocations to alternative investment managers will grow further, she says, while government bonds deliver only miserly yields and returns from equities are forecast to be substantially weaker than those achieved historically.
Despite the rise in allocations, however, managers of alternative investments are under greater scrutiny than ever from pension funds and sovereign wealth funds, which are demanding clear evidence that their interests are being served.
“Investors have become more mindful of value for money,” says Ms Nikulina, adding that investors want alternative investment managers to carry a greater share of the downside risks if a strategy goes wrong.
Last year the OECD, the Paris-based group of rich nations,
warned that pension fund managers and life insurance companies were increasing their chances of going bust if they moved aggressively into alternative assets to meet their promises to savers.
The OECD also called on regulators and policymakers to remain vigilant in assessing the exposure of pension funds and insurance companies to riskier alternative investments.
The global alternatives survey, which has been extended to cover 10 asset classes and seven investor types, shows that total alternative assets under management globally stood at $6.2tn at the start of the year, spread across 602 managers.
Pension funds remain the largest allocator to alternatives, accounting for 41 per cent ($1.5tn) of the total assets managed by the top 100 alternative managers.
“Alternatives managers continue to be remarkably reliant on pension fund money,” says Ms Nikulina, adding that if alternative investment managers lowered their fees they would attract greater inflows from insurers and sovereign wealth funds.
JPMorgan was the world’s largest manager of alternative assets on behalf of pension funds, helped by a strong performance by its real estate and infrastructure arms. Its pension assets rose 10.7 per cent to $75.6bn in 2015.
Anton Pil, global co-head of alternatives at JPMorgan Asset Management, says: “Alternative strategies take time to play out but it makes sense for long-term investors to take advantage of the illiquidity premiums offered by alternatives.”
Last year’s winner,
Blackstone, did not disclose a breakdown for several asset classes and so dropped to 16th place in the list. However, Blackstone’s total assets increased 30 per cent, suggesting it might have retained its position as the biggest alternative asset manager for pension funds if it had reported its data fully.
The study also shows that money has continued to pour into real estate, which remains the most popular asset class for institutional investors. It accounts for just over a third ($1,242bn) of the assets managed by the top 100 managers.
Los Angeles-based
CBRE retained the top spot as the largest property manager, with assets managed on behalf of pension funds rising 2.9 per cent to $45bn. CBRE’s lead has narrowed over New York-based TIAA and JPMorgan, which both saw an increase of 15 per cent in real estate assets managed for pension funds, to $45bn and $43bn respectively.
Fundraising also remained strong for private equity managers, which are now sitting on a record amount of unallocated capital known as “dry power”. This has fuelled concerns that private equity managers will overpay to carry out deals and may damage future returns.
Ms Nikulina says “meticulous selectivity” will be required to identify private equity managers with the right skills to navigate the next phase of the business cycle.
Hedge fund managers, meanwhile, attracted relatively modest inflows in 2015 amid widespread concerns about high fees and poor returns. Almost half (45 per cent) of hedge funds posted losses in 2015 and the industry overall delivered a -0.85 per cent return last year, according to HFR, the data provider.
In January last year Europe’s second-largest public pension fund, PFZW,
withdrew all of its €4.2bn investment in hedge funds because of concerns about the investment performance, costs and complexity of the holdings.
Ms Nikulina says that competitive pressures are growing for hedge fund managers from providers of low-cost smart beta strategies, a halfway house between active and passive management.
Size has also become an issue, not just for hedge funds but for all alternative asset managers. Amin Rajan, chief executive of Create, the fund management consultancy, says: “Asset inflows are a double-edged sword for alternatives managers as their strategies are not scaleable as investments in equities and bonds.”
He warns that “the wall of new money is diluting returns from alternatives”, adding that downward pressure on fees, particularly on funds that have mediocre performance, is “intense”.
But Mr Rajan expects to see more money flowing into alternatives from institutional investors, which are deeply worried about the end of the 35-year bull market in bonds and the risks in equity markets.
“The two main asset classes [equities and bonds] carry huge risks that could be absolutely crippling, particularly for pension funds where growing numbers are being forced to eat into their capital to pay retirement benefits,” he says.
Rob Mellor, a partner with PwC, the professional services provider, agrees. “Negative interest rates will drive a shift out of bond markets and the place to go is alternatives managers,” he says.
