In 2012, pension investments in alternatives run the gamut from large plans structuring their own hedge fund of funds to smaller plans just dipping their toes in the water. One thing is clear, however: After nearly a decade of experimenting with alternatives, defined benefit (DB) plan sponsors are now comfortable with investing in assets other than the standard bonds and equities.
The quest for higher returns and less volatility has driven many private plan sponsors down the path that governmental plans and endowments traveled years ago. DB plans are looking for investments that perform well in periods of high volatility, says Caren Bianco, director at PwC’s Global Human Resource Services in New York. Bonds have lost appeal because the yields are too low, she says, so sponsors are eying alternatives with newfound interest. Sponsors have seen hedge funds provide consistent performance relative to bonds and equities, says Sherwood Yuen, a vice president and consultant in Callan’s Alternatives Consulting group, so now more of Callan’s clients are allocating assets to alternatives, he says.
Additionally, most corporate plans have “hurdle rates” of 8% to 9% return on investment that their assets need to earn, says Alan Kosan, senior vice president and head of the Alpha Investment Research group for Segal Rogerscasey. With returns on bonds low and equities moving sideways, this means that plans are gravitating toward higher-yielding strategies—like alternatives. “If they need growth,” he says, “alternatives have to be in the portfolio.”
But while acceptance has grown, according to Bianco, private-sector DB plan allocations to alternatives are still limited. Smaller plan sponsors (less than $100 million in assets) are still not investing in alternatives, she says, as many lack the staffing to perform the necessary due diligence; plus, the small size of the potential investments makes them less attractive to managers.
Plans already investing in alternatives, however, are expanding their repertoire. The traditional investment route has been through a hedge fund of funds, which sponsors considered safer. Within the last few years, though, while plans continue to invest in commingled funds, many have begun investing in hedge funds directly, Yuen says.
Plans also use direct investment as a tool to help them strategize. “Plans are investing directly with hedge funds to find strategies that meet their needs,” says Bianco, “particularly to hedge against tail risk and protect themselves against another adverse market year like 2008.”
One way fund of funds managers have responded to the move into direct investment is by offering more customization, says Yuen. Some managers now provide fund structures that fund one type of structure or create plan-specific funds of funds built around the sponsor’s specific needs.