Pension funds must be “extraordinarily cautious” when investing in illiquid property, as rising rates of interest and falling inventory markets improve the probability of their having to entry money shortly, the OECD has warned.
Within the latest period of low rates of interest, pension funds poured cash into various investments, resembling infrastructure initiatives and personal fairness, in an effort to flee the low yields out there on authorities bonds.
However such investments are usually illiquid, that means the funds can’t shortly convert them into money if wanted. Whereas there was no use for funds to do this over the previous decade, the UK pension crisis in October uncovered how a pointy rise in rates of interest can change that.
“There’s a name now for higher flexibility in regulation to permit [defined contribution] schemes to put money into illiquids and infrastructure and that is positive,” mentioned Pablo Antolin, principal economist on the personal pension unit of the OECD Monetary Affairs Division. “However we additionally need to be extraordinarily cautious as a result of liquidity points are crucial within the administration of funding methods.”
Alongside the liquidity dangers, the OECD cautioned that the extent of due diligence required on various investments is more likely to be past the attain of many smaller funds.
“When you will have an enormous pension fund, with a big funding staff, which is extra extremely certified, they will afford to make these decisions and assess these illiquids fairly effectively to introduce them,” mentioned Antolin. “However small and medium-sized pension funds can’t and so they want the monetary devices to speculate . . . What we’ve seen is there usually are not many monetary devices on the market to put money into illiquids and infrastructure.”
The warning comes as pension funds’ urge for food for various investments present little signal of slowing. In December, BlackRock, the world’s largest asset supervisor, mentioned the position of personal property, which span all the things from infrastructure to non-public credit score, is turning into “extra necessary than ever” as extra firms flip to them for returns.
Allocations to various property have introduced advantages to world public pension plans.
For instance, the Virginia Retirement System, which has 778,000 members, reported its holdings of public shares and stuck revenue have been down 14.8 per cent and 10.6 per cent respectively for its 2022 fiscal 12 months. In distinction, its actual property and personal fairness returned 21.7 per cent and 27.4 per cent over the identical interval.
Nearly half of public pension funds globally with greater than $3tn in property plan to extend their publicity to alternate options, in accordance with a latest survey by the Official Financial and Monetary Establishments Discussion board (OMFIF).
Belongings that present a hedge in opposition to inflation, together with infrastructure and a few actual property, have been amongst these most favoured, the survey discovered.
“Given this stark outperformance and lingering issues amongst [global pension funds] about inflation, it’s no shock that there’s urge for food to maneuver additional into actual property and personal fairness,” OMFIF mentioned at an unbiased discussion board for central banking, financial coverage and public funding.
Nonetheless, OMFIF identified the dangers on this method.
“Chasing larger returns in comparatively illiquid markets offers funds much less flexibility to alter their methods in future,” the report mentioned, including that “the latest UK pension disaster suggests it’s needed to carry liquid property as a strategy to immediately elevate money in unhealthy instances”.
