Evergreen possibilities for alternative investments
PENSIOEN PRO PARTNER ROUNDTABLE
As pension funds begin to alter their benefits and investment strategies under the new national reform, Pensioen Pro gathered senior professionals around the table to discuss the role of alternative investments. Alternative investments is a broad category but this event concentrated on debt and equity in infrastructure, real estate and other privately-held enterprises.
Is there added value?
The conversation began with the worries of pension fund managers. Cees Harm van den Berg, expert strategist at APG, noted that people are saying there will be less room for alternative investments in the new system, but he would disagree. Danny van Wijk, manager selector in private markets at MN, said his main concern will be the calculation of Net Asset Values (NAVs) for private enterprises when the reporting lag to Limited Partners currently is routinely 90 days after the period measured, in contrast to a daily available NAV for listed positions.
Daan Muusers, trustee on the investment committee for three pension funds, was frustrated by just how illiquid private-assets vehicles remain. “You can play around a little bit with liquidity by taking dividends and then not committing to re-invest,” he said. “But it still takes at least one year to get out.”
Rabobank Pension Fund is preparing the transition to a flexible premium agreement, aiming to start January 2027. Chris Doornekamp, investment manager for the fund, said that the flexible contract will put some limitations on alternative investments. “We need sufficient liquidity in the new set up with lifecycles and underlying modules (building blocks). Our fund also strives for competitive costs and alternatives are typically not the cheapest category. On a positive note: alternatives can make the portfolio more robust and can offer good opportunities for making real impact.”
Michel Iglesias de Sol, investment adviser to three pension funds, said that for long-term investors, it was very important to invest in the real economy especially under the solidarity-based premium scheme.
He said that the three funds he advised were still working their way towards the new regulations. He suspects that investment policy will be reformed after the new regime takes effect.
Similarities and differences
Michael Steingold, director of private markets at Russell Investments, was then asked what similarities and differences he observed between the new Dutch system and others around the world.
Steingold has advised major public and company-sponsored retirement plans in Canada, Australia, the Middle East and Japan, notably a large government pension fund there. He said that the first major similarity was managing liquidity. The second was visibility. “That means incorporating data from private assets into overall portfolio management – so information from private assets sits alongside information from public securities.”
The third theme was building blocks, for which Russell Investments has its own categorisations.
On liquidity, he said the challenge for Dutch pension funds was transitioning from being long-term investors with the ability to be patient, to a DC system. Steingold pointed to the new wave of products in each category of private assets that were semi-liquid and evergreen. He noted the shift in the mindset of General Partners – the firms that manage these assets – that had enabled the new wave. “Previously, they had to focus on what they would earn at the end of a vehicle’s life in performance fees. With the advent of large-scale evergreens, that has now changed.”
On visibility, Steingold said: “You can introduce incrementally better liquidity if you have the right tools to see public and private holdings alongside one another.” He explained that Russell Investments has proprietary tools for this but also mentioned iLEVEL from S&P and Backstop Solutions. “You always suffer from a reporting lag, but we are shortening that lag and making more informed decisions at the overall portfolio level as a result.”
On building blocks, Steingold said it was a common challenge around the world for in-house pension teams to upscale their skill acquired managing local direct assets to an international portfolio. “As your book of assets expands, then going indirect can be a more efficient solution.”
Per country, Steingold noted that the challenge in Australia is that the concentration of assets among Super funds is increasing. As the number of providers dwindles, execution challenges rise. In other words, size can become problematic.
Muusers predicted that the new Dutch system will follow the same trend as Australia.
Steingold noted that the U.S. has been shifting for decades from Defined benefit to Defined contribution. He said that semi-liquid, evergreen vehicles worked well here. In contrast, he expressed caution at products for professionally managed portfolios that mingled private assets with a minority of quoted securities with exposure to sectors such as real estate and infrastructure. The laudable motivation was to achieve the desired liquidity for DC plans. But Steingold’s concern with these hybrid strategies was the introduction of equity market beta and volatility into a part of the portfolio expected to behave like pure private assets. Other parts of the portfolio could be tapped to provide the needed liquidity more efficiently. He added that requiring this type of hybrid gave investors a much smaller universe from which to choose.
Rabobank Pension fund’s new set-up
Doornekamp said more about the Rabobank Pension Fund’s new set-up in the flexible premium agreement. “We will make use of three ‘building blocks’ to create lifecycles: return, interest rate and matching. In our case, alternatives will be part of the building block return. Next to equities, we also invest in categories like real estate, private equity and infrastructure. To safeguard sufficient liquidity in stress scenarios, the total weight of alternatives will be set at 30% of the return module. Our calculations show that in a stress scenario the weight of illiquid assets will not exceed 50% of total, which is still manageable.”
Van den Berg acknowledged the wisdom of this strategy: “You always have to expect under the new system that participants can change their risk profile all of a sudden, which requires a source of liquidity.”
You can introduce incrementally better liquidity if you see public and private holdings alongside one another
Doornekamp added that participants also have the opportunity to take a sizeable lump sum – 10% of their total pot at retirement date. So that is another liquidity consideration. “But large market shocks remain the biggest challenge by far, especially a stagflation scenario. When a market crisis occurs, we can take time to rebalance the investments within each building block. However, we need to follow the path of the lifecycles without delay, so we need to be able to make transactions across the building blocks at any time.”
Communication challenges
The Pensioen Pro roundtable was then asked about communication under the new regime.
Muusers answered that this depends on the participants. “Almost no one in the Cleaners’ pension fund thinks their pension fund is investing,” he said. “Even the S&P500 is a risk to them. If the market drops 10%, they will be nervous.”
Van den Berg suggested that in this scenario, illiquids could seem more safe by providing some (artificial) stability in returns.
Muusers replied: “But the decline is lagging. How do you explain that?”
Steingold noted that when COVID struck, publicly traded assets moved fast whereas privates hardly budged at all. He added that Australia has introduced requirements for DC plans to test asset valuations in order to give regulators comfort. “At that time, we were quickly testing whether private assets reflected the values implied in public markets, swapping stale data for a reality check. You need the right expertise to do this consistently and appropriately.”
Van den Berg said that it might not be necessary to do this if we can explain to participants that returns are lagging. But he recognised the challenge: “We already see difficulties explaining to board members.”
Iglesias del Sol queried whether individual participants would see individual asset prices. Van den Berg replied that they would not. “But when they see the S&P500 moving 5% and their own pension assets by -5%, then they will pick up the phone.”
“Communications will be an enormous challenge,” Iglesias del Sol concluded.
Van Wijk reiterated that the private assets portfolio would not move as public markets, not only because of the valuation and reporting lag but also because a large pension fund has exposure to multiple General Partners, and each vehicle would in turn have 10-15 underlying investments. “You can compare with public markets but there is no crossover,” he said.
Doornekamp said that stale (lagged) pricing for alternative investments is a fact of life, but in the new contract there will be a more direct link with participants. “There is pressure on alternative managers to deliver frequent and accurate valuations. Pension funds can partly mitigate this issue by limiting the number of times that participants can switch their preferences.” He asked if the U.S. real estate market could set a good example, as US real estate managers co-operate with valuation management companies to deliver daily pricing. Steingold said it was a mechanical, accretion approach. “This is straightforward if you have a discount rate: just take that discount rate as an assumed return, and accrete evenly each day through the period. A true-up in values is needed at the end of the period when the new valuations data arrives. Because these true-ups can be positive or negative, there is symmetry for investors getting in and out, which means values are fair.”
Plan managers have a lot of options to customise the specific valuation approach to best match the needs of the specific plan. For example, a key question is how much daily inflows and outflows may be expected.
Comparing alternatives
Van den Berg said that private equity is the most difficult under the current legislation, due to the required solvency buffer, but also fees, transparency and a reporting lag. But he doubted that even if there were no solvency buffer and reporting lag, greater exposure to Private Equity would be triggered, due to the remaining challenges.
He said that current buffer requirements also punish infrastructure, which has very attractive characteristics and might see an increase under the new legislation. Muusers noted that infrastructure is still private equity. Van den Berg replied: “I think infrastructure is an asset class per se: more direct inflation than private equity, but with the appeal of the ownership structure. APG has done joint ventures to own infrastructure outright.”
Muusers said that was the advantage of being APG. “You are big. We, on the other hand, always need a middleman.”
Iglesias del Sol said that infrastructure offered more steady income streams, especially contractual income. He noted that timberland and farmland, for example, were private equity but with a very different risk profile. “Crops give a direct yield plus land appreciation.”
You always suffer from a reporting lag, but we are shortening that lag
On infrastructure, Steingold observed that it has a very low correlation to real estate through the cycle, because those assets are less sensitive to the economic cycle and to interest rates. He picked out the digital sector – data centres, fibre networks and mobile towers – as one exciting area of growth for infrastructure as Artificial Intelligence and other computationally intensive technologies work their way into the economy. Timberland and farmland have higher correlations to real estate because all three have the similar exposure to value drivers.
Alternatives versus the classic 60/40 allocation
Muusers asked for more information on where to find the opportunities today. “We have had some exposure to all the discussed categories. Results on a total return basis over ten years and more were disappointing overall. Therefore we shut down most of them.”
“That is what we see,” said Van den Berg. “A classic 60/40 equity/bond allocation with plenty of allocation to Dutch govies has performed very well since 2010.”
Iglesias del Sol was not convinced by arguments for a 60/40 portfolio outperforming. He noted the concentration of return coming from a handful of US tech stocks. He warned that you need to be diversified in a crisis, but that message was difficult to convey in conversations currently.
Steingold responded that investors do best in private markets when they are diversified. Invest over time and through cycles. He recalled some U.S. government-sponsored pension funds deciding to stop allocating to illiquids following the Global Financial Crisis and so missing the great vintages in the early cycle.
“It’s really tough to overcome those behavioural economics,” he said.
Van Wijk agreed that private markets you cannot time at all. He noted that long-term returns for MN from private equity have been above the long-term strategic benchmark for the asset class. He suggested that smaller pension funds could work together to build these exposures.
Greater collaboration, however, would bring other challenges, to overcome different preferences of not only pension fund boards but also individual members under the new system.
Making an impact
Those differences are evident within the trend towards Impact investing. Rabobank Pension Fund has recently adopted an impact framework, according to Doornekamp. “Our impact themes are focussed on climate change, food transition and sustainable living. These themes are aligned with our sponsor Rabobank and our participants,” he said. Our target allocation for impact investing is 10% of our total portfolio in 2030. Alternative investments can play an important role to achieve this goal.”
“Private markets have additionality whereas public securities are just bought and sold,” said Iglesias del Sol. “In private markets you have added new capital, which satisfies intentionality.”
Van Wijk agreed that Impact is a hot topic but said it is hard to find opportunities that meet all the criteria.
Steingold said it takes a specialist team to implement what beneficiaries and the board want. Russell has seven-year track record managing Impact portfolios for a Dutch institutional investor. Steingold’s observation on the market in general was that there had not been much trade-off between return and impact in the last cycle: “When that trade-off grows, it will be a challenge.”
Contact us
For further information about alternative investments.
Martijn Kuipers
Managing Director Europe, OCIO/FM
Russell Investments
E mkuipers@russellinvestments.com
T +31 20 5674313
Participants:
→ Danny van Wijk MN
→ Chris Doornekamp Rabobank Pensioenfonds
→ Cees Harm van den Berg APG
→ Michel Iglesias de Sol Pf PNO Media, Vlakglas, Staples
→ Daan Muusers Pf Schoonmaak, Levensmiddelen, VLEP
→ Michael Steingold Russell Investments
→ Martijn Kuipers Russell Investments
→ Mariska van der Westen FD Business
→ Tom Jessen moderator