Are there lessons for other pension fund trustees in the news that the £20bn government-mandated Pension Protection Fund (PPF) is embracing alternative assets? We think so.
The PPF, established to protect members of company schemes whose employers are insolvent, is considering increasing its holdings of alternative assets that don’t have a high correlation to traditional pension fund investments.
In particular, the fund’s “freedom to hunt down illiquid opportunities in the alternatives world” is a key plank to reducing its deficit. The PPF is now focused on finding assets that are uncorrelated to traditional listed equities, according to the Financial Times.
Our view is that the PPF is faced with an issue common to many pension funds: how to achieve genuine diversification and maximise risk-adjusted returns. Yet the traditional approach to this critical discipline often ignores or overlooks key asset classes that can benefit pension funds on both fronts, focusing instead on an unnecessarily narrow asset opportunity set.
This reflects both a lack of expertise in alternative assets among some of the mainstream investment advisories but also a tendency to give backward-looking advice, focusing on what has worked well over the past several years rather than looking forward to what will work well over the long-term. Equities have enjoyed good returns in recent years, and advisors are looking at increasing exposure, forgetting the painful lessons of 2008. It seems that memories are short and investors are once again becoming complacent.
The PPF recognises the inherent risk in the traditional approach, and the value of adding alternative investment strategies to diversify the risk/reward profile of its portfolio. In fact, its “unusual asset allocation model” includes just a 10% allocation to equities and a 20% strategic allocation to alternative investments.
Gatemore has a similar mindset, recognising that it is not common sense to be over exposed to any particular asset class, especially one that has seen a large run up in price and looks less appealing from a valuation perspective. Instead, we take a forward-thinking approach, seeking out alternative strategies with low correlation to the equity markets. These should offer downside protection when the winds shift and equities fall out of favour.
Diversifying into so-called ‘alternative’ assets, which may include absolute return funds, private equity, property, infrastructure and commodities, is essential for any portfolio focused on risk-adjusted returns.
Alternative investments, particularly those with low correlations to traditional markets such as equity and fixed income, can provide a margin of safety when those traditional markets go south.
With proven manager selection skill in these areas there is nothing ‘alternative’ about these essential portfolio components to us.