(August 6, 2012) – Alternative assets are the only way for plan sponsors to reach their 7% or 8% return targets, according to Blackstone President and CEO Tony James.
In a Monday post on the private equity firm’s website, James argued that if the “nation is going to be able to provide for its future, pension funds and other institutional investors must earn more than they can get in public markets. “And,” he continued, “they must do so on a scale large enough to move the return materially on hundreds of billions of dollars. I believe that only alternative investments can fill this need. Indeed, I don’t think the US pension system can come close to being solvent without having major investments in alternative assets.”
Over the last few years, US fixed-income investments have tracked, on average, with solid performance for institutional funds, according to new data from Wilshire. But buying security is increasingly expensive. Interest rates in most of the Western world are negative in real terms, and many bonds with handsome yields originate a little too close to the Mediterranean for plenty of CIOs’ comfort threshold.
Exposure to equity markets, which have been weak and highly volatile, was directly correlated with lower one- and three-year returns for institutional plans, according to the same data from Wilshire. And James believes returns on equity won’t be improving any time soon. “As an economy,” he wrote, “we are going to be looking at slower real growth than we are used to. In the last 40 years we have had a leveraging up cycle which artificially inflated real growth in our economy, and now, and I think for quite a while, we’re going to have a deleveraging cycle that will retard real growth.”
Still, the enormous variety of risk profiles and strategies that fall under the ‘alternative asset’ umbrella means increasing allocation in that direction isn’t a simple decision for any plan sponsor—or it shouldn’t be. The class of assets also tend to carry higher fees with less transparency, compared to equities and fixed income. State public pensions already spent nearly $8 billion in management fees last year, and are not eager to increase that.
James didn’t speak to the issue of fees or transparency, but does concede that alternative assets tend to lack liquidity. But, he argues, liquidity isn’t something institutional investors particularly need. “Pension plans in general have more than enough liquidity,” he wrote. They own plenty of tradeable bonds and plenty of public stocks. There is not a need to have instant access to vast amounts of liquidity in any pension system. It is predictable when people age and what they are entitled to receive in distributions. Most institutions over-invest in liquidity, and they pay a significant penalty in their returns for doing so.” James concluded: “I think most of them will come to realize that alternatives are really their only viable solution.”
See Tony James’ entire post here.