Low-interest rate environments in many developed nations, alongside increasingly volatile equity markets, are leading pension funds to adapt their investment strategies. In their search for yield, many are looking outside their borders as well as investing in alternatives, according to a new report by the Association of the Luxembourg Fund Industry (ALFI) produced by PwC Luxembourg.
The report, which examines the growth of pension-fund assets, their foreign-investment limits, and other key trends, shows that pension-fund assets globally are expected to grow at a 5.4% Compound Annual Growth Rate (CAGR) between 2018 and 2025, rising from US$42.2 trillion to US$61.1 trillion. Latin American pension funds are expected to see the strongest CAGR with assets soaring by over 12% to reach US$2.4 trillion.
In terms of asset allocation, equity continues to hold the crown, accounting for 38% of total pension assets at the end of 2018. However, growth, in percentage terms, has turned negative – with allocation falling from 60% in 1998. Alternatives are expected to play an increasingly important role in pension funds’ portfolios as they continue to search for yield. In absolute terms, pension fund alternatives AUM has risen from US$9.2 trillion in 2014 to US$11.6 trillion at the end of 2018.
Globally, regulations governing pension fund foreign exposure continue to differ drastically. While the majority of countries examined do not set any limits regarding foreign investments, some have set limits for non-OECD or non-EEA countries. Additionally, others have set limits for specific asset classes. Overall, however, there has been an increase in pension funds’ foreign exposure since 2014, rising from 31% to 34% at the end of 2018.
Corinne Lamesch, ALFI Chairperson, comments, “Pension fund regulations still differ from one country to the other. In particular, some countries restrict the amount pension funds can allocate to investment funds or foreign investments. Consequently, navigating the terrain of complex local requirements can be challenging for asset managers.”
Oliver Weber, head of asset and wealth management, PwC Luxembourg, comments, “In light of the current global investment environment, pension funds, with their ability to weather periods of market instability, are also upping their allocations to alternatives, including notably illiquid assets such as private equity and infrastructure. In search for diversification, pension funds are not only looking in terms of asset class, but also geography. They are going beyond their borders in search for growth – either through direct investments or, increasingly, using funds such as AIFs or UCITS.”
Key findings of the report include:
• On a regional basis, North American pension funds still account for the majority of AUM, holding 61% of global pension assets at the end of 2018.
• On a global level, equities account for 38% of total assets at the end of 2018, bonds for 29% and alternatives for 27%. Money market and investment funds (UCITS and AIF) accounted for the rest. Allocation varies significantly across regions, with APAC pension funds allocating the most to equity (51%), followed by North America (42%), Latin America (26%), and Europe (20%).
• The US, Canada, Japan and Australia pursued the largest equity investments in 2018, allocating US$10.6 trillion, US$723 billion, US$691 billion, and US$626 billion respectively to the asset class.
• Alternatives were a large driver of growth across the globe for pension funds. Latin America saw the strongest growth in this space, albeit from a low base, with private equity investments contributing to the double-digit growth.
• Despite the strong growth, alternatives still only account for 5% of Latin American pension fund assets, the lowest of all the regions. North American pension funds hold 31% of their assets in alternatives, followed by Europe (27%) and APAC (8%).
• AIFs have emerged as a key vehicle for pension funds looking to structure their alternative investments. Pension funds are already the main investors in AIFs, accounting for 26% of AIF assets at the end of 2017. Given the increased levels of protection that AIFs offer, we expect more pension funds to turn to this vehicle in the future.
• Globally, the average foreign investment of pension funds for considered countries stands at 34% of their assets, however regionally the differences are stark.
• Europe has one of the most developed markets, with pension funds from the region allocating 35% of their assets to foreign markets.
• While the US does not set any quantitative limit, there are stark differences between funds.
• APAC pension funds had a strong allocation to foreign investments, investing, on average, 38% of their assets to external markets.
• Latin American pension funds had the lowest allocation to foreign assets, standing at 27% at the end of 2018. However, exposure differed vastly by country, with Brazilian pension funds, for example, only investing less than 1% of assets in foreign markets. Chilean pension funds, on the other hand, invest approximately 43% of their investments in foreign markets.
• Pension funds look to align their investments with Sustainable Development Goals (SDGs) and Environmental, Social & Governance (ESG) factors, with EU pension funds leading the pack.
• Member states across the union have developed (or are in the process of developing) initiatives to encourage ESG integration by pension funds. In the UK, the Department of Work and Pensions issued a new regulation requiring pension funds to consider ESG and ethical elements during investment decisions. In France, the 2015 law on energy transition for green growth, created mandatory ESG and climate policy reporting for all asset owners.
Corrine Lamesch concludes: “Another key development since the 2015 edition of the report is the growing focus on sustainability of the investments made by pension funds. Luxembourg has been a pioneer in this field and is today the leading domicile for sustainable funds in Europe. Further, UCITS remains a key vehicle for many pension funds seeking exposure to worldwide markets. We expect this trend to continue given the sound regulatory framework, the high level of investor protection and the depth of global capability embedded in the structure.”