Pension funds continue alternatives push in 2016, positive for ILS

The world’s pension funds continued to push more deeply into alternative investments in 2016, as asset classes which offer diversification continue to prove very attractive to a growing sector which now commands a total of $36.4 trillion of investments at year-end 2016.

Institutional pension funds are the largest investor segment of the insurance-linked securities (ILS) market, having grown steadily in the space over the last few years. It’s now common for a major pension fund to have from half a percent to three percent, or higher, of its assets invested in ILS and other reinsurance linked investments.

So when the pension fund grows its asset base it’s safe to assume that the appetite for ILS investments will continue to grow and remain strong, particularly when pensions are still pouring increasing amounts of capital into alternative asset classes that offer an element of diversification for their portfolios.

Over the course of last year institutional pension funds grew their total assets by 4.3%, ending 2016 with $36.4 trillion of assets, according to figures from insurance, reinsurance broker and advisory Willis Towers Watson’s latest Global Pension Assets Study.

Over the last five years the study shows that pension fund assets have grown at 3.8% on average per annum (in USD), although the rate varies significantly, from a shrinking -5.4% in Japan to an expansive +20.3% in China.

In the last couple of decades institutional pension investors have downsized their allocations to equities and bonds, although this has been offset by the increasing interest in alternative asset classes, according to Willis Towers Watson.

In 2016 this benefited pension funds, as alternatives are cited as one area of their portfolios that produced gains “ahead of expectations.”

The shift to alternatives has not simply been a story of hunting for yield in a low-yield world, pension funds are actively seeking out asset classes that bring qualities to their portfolios, such as diversification or lower correlation with broader financial market drivers.

“Managing risk has continued to be a focal point for pension funds around the world. The principal strategy for this is increased diversification, as evidenced in the upward trend in allocations to alternative assets and a sustained shift from domestic equities markets,” explained Roger Urwin, global head of investment content at Willis Towers Watson.

Alternatives are a major part of many pension funds strategies today, with those from the biggest pension markets now allocating around 24% to other assets such as real estate and other alternative classes. Impressively that percentage has risen from just 4% as recently as 1997.

Of course insurance-linked securities (ILS), such as catastrophe bonds and other collateralised reinsurance linked assets, are now becoming increasingly commonplace among pension funds, but allocations for most are small even within their alternatives segment of the portfolios.

The continued demand growth for alternatives suggests that a relatively stable (over the longer term), relatively uncorrelated, diversifying return driver such as ILS should continue to benefit from this demand, as more pensions discover the asset class and those already invested get increasingly comfortable.

The ILS market can help to tap into the demand for alternatives, by creating new products, encouraging pensions to invest more directly and perhaps for the larger pensions through their own vehicles.

Traditional insurance and reinsurance companies can also help pensions access risk in ILS form, partnering with them as providers of efficient capital, bringing that capital within their own underwriting business and acting as underwriting and risk portfolio service providers for the world’s bigger pension funds.

It should all add up to continued growth in interest and allocations to ILS.

As we wrote recently, almost one-quarter of pension plans said that they are actively considering making new investments into the insurance-linked securities (ILS) asset class, in response to a recent survey.

But education remains an issue and half of those surveyed said getting their pension trustees comfortable with the ILS asset class is the largest hurdle they face to making an allocation.

ILS remains a relatively esoteric asset class to many in the investment community and it is down to the market to increase education and marketing of the product, to make it as accessible as possible (for what is a very complex asset).

Increasing interest and growth in alternatives can only be a good thing though, as by becoming part of more pension managers consideration set the ILS market can only benefit through increased capital inflows further down the line.