Diversification in focus for world’s largest pension funds

Many of the world’s largest pension fund investors are actively seeking out diversification opportunities, as they shift portfolios in light of global economic volatility, which could serve to further raise the profile of ILS investments.

A recent piece of research from brokerage and consultant WTW states that out of the top 20 pension funds in the world, 9 of them highlighted the importance of diversification as a strategy during the global economic slowdown that’s being experienced.

Assets under management (AUM) of the world’s top 300 pension funds soared by 8.9% to reach a new record of US $23.6 trillion in 2021, the research states.

Growth in assets has slowed somewhat, on the back of the challenging macro-economic and capital markets environment, which is now driving an increasing focus on portfolio management to support target returns at pensions.

Marisa Hall, co-head of the Thinking Ahead Institute, an innovation network formed by WTW, commented on the global pension fund landscape, “Looking ahead, rising inflation and subsequent central bank action are likely to cause global growth to falter, which may in turn endanger longer term the funding status of pension funds.

“Pension funds are also under immense governance pressure from all sides, with a growing politicisation of ESG in some regions meeting calls for more substantial and urgent climate action. The addition of stark short-term economic pressures alongside these structural long-term changes will only add to the difficulty of balancing short-term financial resilience with long-term financial and climate sustainability.

“We’re seeing asset allocation continue to respond to long-term structural shifts. While allocations to private markets declined compared to the previous year, we believe this was mostly caused by shorter-term inflationary and rate-hike fears. We expect private markets will continue to expand considerably in the investment space over the long term, reflecting a need for new primary investment to support new models of sustainable economic growth.

“Pension fund boards’ agendas have rightly become a guide to the complex strategic challenges facing global markets and economies.

“The majority are concerned about growing market volatility and discussing further ways to boost the diversity of their investments, specifically in the context of global economic slowdown.”

With diversification in focus the insurance-linked securities (ILS) asset class and other reinsurance linked investment opportunities are certain to be one area of opportunity that major pensions discuss with their consultants.

Sourcing returns from asset classes that are relatively uncorrelated with the broader financial markets is becoming more of a focus for these major pensions at this time and some pensions have been looking for new opportunities to add more diversity to their portfolios.

ILS has a strong story to tell, especially in times of rising interest rates.

During historical periods where interest rates were increasing, the ILS market has delivered benchmark beating returns, studies have previously shown.

This year, while ILS returns have been depressed somewhat by price pressure, in catastrophe bonds at least, the asset class has continued to beat benchmarks, by a considerable margin, in many cases.

Now, with the price pressure behind the asset class, we can see cat bond fund returns steadily rising through recent weeks, while many private ILS strategies have been delivering more than one percent each month in returns of late.

So these dynamics, of pensions looking for diversification, volatility in financial markets, and benchmark beating ILS assets, are set to deliver greater interest in the ILS asset class over the rest of this year and into 2023, our sources suggest.

Catastrophe bonds are a key focus at this time, with many investors now having spotted the higher return potential of cat bonds at a time when they can offer even more attractive returns in an investment format with greater liquidity.

But we’re told private ILS are also coming into focus in pension fund’s research of diversifying asset classes, suggesting the education process is in full-swing for some potential allocators to the sector.

Closing on allocations remains hard, of course, while issues such as asset allocation protocols are also holding back some pension funds.

But, as this year progresses, it will be interesting to see how flows are managed across the ILS market and whether ILS managers can capitalise on the increasing interest in diversifying assets that major pensions are showing at this time.