3 minute read 21 Jun 2019
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How alternative assets are key to delivering superior pensions returns

By

Josef Pilger

EY Global Pension and Retirement Leader

Passionate about helping governments, providers and members to more effectively tackle demographic transformation. Champion for better retirement outcomes for all.

3 minute read 21 Jun 2019

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Asia-Pacific boasts attractive direct investment opportunities, but the rules of engagement need to change in order to reap the rewards.

Our 2018 Global Pension Study revealed 69% of respondents agreed or strongly agreed that lower returns will drive more investments into alternative asset classes. These classes, which include private equity, infrastructure, real estate or private credit, already represent almost US$10 trillion globally. In 2018, pension funds represented more than one-third of infrastructure investors, with 84% of respondents saying they were satisfied or very satisfied with their infrastructure investments.

It’s clear that alternatives are looking highly attractive, and Asia-Pacific and Japan offer tremendous direct investment opportunities.

According to Jonathon Zhao, EY Asia-Pacific Financial Services Transaction Leader, “regional pension, retirement and social security organizations must step up their direct investment game quickly if they are to retain maximum value for their members.”

In a competitive market for attractive and bankable deals, professional investment governance is essential. Boards must support swift decision-making, delegating authority prudently so executives can identify and close attractive deals.

How can funds safely increase their allocations to alternative assets?

Organizations, their trustees and policymakers consider five “C's” when entering or expanding their direct investment footprint in alternative assets:

  1. Charter — Many organizations across the region have not modernized their investment beliefs or strategic frameworks to reflect the broader modern investment universe. Investment restrictions are often hard coded in their charter, where clauses often prohibit overseas and direct investments completely — or restrict them to a small percentage. What charter changes are necessary and politically feasible to enable increased allocations to direct investments in alternative assets?

  2. Capacity — As a starting point, funds need a large enough investment ticket size and adequate cash flows to benefit from investments in less liquid instruments. But, more than this, many funds also need to adjust their investment beliefs and culture. Do we have enough long-term capacity to invest directly and reap the rewards from illiquidity premiums? 

  3. Capabilities — When funds use their domestic investment expertise as starting point to venture overseas, success often remains elusive. Our 2018 study offers us one possible reason for this: more than a third of respondents agree or strongly agree that their operational maturity and capabilities are not aligned with the size and complexity of their investments and portfolios.

    In a competitive market for attractive and bankable deals, professional investment governance is essential. Boards must support swift decision-making, delegating authority prudently so executives can identify and close attractive deals. This capability is pivotal when competing with professional overseas asset owners and asset managers all fighting for the same deal.

    But closing the deal is only the first step to success. Converting a deal into attractive ongoing value creation requires professional management, an ESG focus, astute proxy voting and a proactive approach to the investor role. In particular, investors should focus on: board resilience and governance, and how capital is being divested and repatriated — often the key lever for success. What capabilities do we need to build or source across the investment life cycle to sustain value creation?

  4. Collaboration — Direct investments cover a wide range of countries, industries, themes and ideas with diverse opportunities and risks. Monitoring and having enough expertise across all these domains exceeds the capabilities of most organizations. Collaboration and intelligent partnering are pivotal to spot, assess and close opportunities. But building and maintaining such trusted partnerships requires a strong brand to start with, plus significant ongoing time and effort. What would a professional partner expect from us to become a peer? Does our culture enable us to build and maintain such long-term partnerships to support our direct investment success?
     
  5. Consumer — Direct investments have been almost exclusively the prerogative of institutional investors making portfolio decisions. But in individual defined contribution funds, where members and retail customers make the investment decisions, funds now need to consider how to make direct investments available outside the default investment option. What do we need to do to make direct investments available for our defined contribution members with investment choices?

Asia-Pacific and Japan have many highly attractive direct investment opportunities on their doorstep. Beyond China’s “Belt and Road,” the Philippines’ “BuildBuildBuild” campaign, Indonesia’s focus on infrastructure or Japan’s infrastructure sale, could all absorb hundreds of billions of patient capital to deliver attractive long-term returns for members.

However, funds must be mindful that the additional investment returns from direct investments come at the price of additional risks. Managing these risks well is part of good governance, fulfilling fiduciary obligations, and acting in the best interest of members and the public.

Summary

It’s clear that alternatives are looking highly attractive, and Asia-Pacific and Japan offer tremendous direct investment opportunities. However, funds must be mindful that the additional investment returns from direct investments come at the price of additional risks. Managing these risks well is part of good governance, fulfilling fiduciary obligations, and acting in the best interest of members and the public.

About this article

By

Josef Pilger

EY Global Pension and Retirement Leader

Passionate about helping governments, providers and members to more effectively tackle demographic transformation. Champion for better retirement outcomes for all.