Public pension plans continued to increase allocations to alternatives and private assets during 2018, particularly to private equity, real assets, and other private market securities, according to a report from Goldman Sachs Asset Management (GSAM).
“These adjustments may be motivated by a need for exposure to higher-returning asset classes to achieve a plan’s long-term expected return target,” said GSAM in its report, “given we are likely entering a period of lower returns across a wide swath of asset classes.”
The report said that increased allocations to real assets may also signal increased concern about inflation, which “has shown signs of life in recent quarters after being dormant for several years.”
In compiling the report, GSAM said it analyzed board minutes and publicly available documents to determine where public pension plans enacted changes to strategic target allocations during the past year.
GSAM noted that while public pensions boosted their allocation to private assets in 2018, they also reduced their allocations to US equities with many rotating to non-US equities. The report said this change was “potentially driven by the outperformance of US equities over non-US equities in recent years.”
The report also found that public pensions increased their allocations to emerging market debt during the past year. It said that an analysis of emerging market debt allocations by large US public defined benefit plans reveals wide adoption either as standalone mandates, or as part of other fixed-income allocations.
“We see [emerging market] debt as undervalued compared to areas such as US corporate bonds,” said the report. “Global growth may have decelerated, but remains above-trend in key economies,” as 97% of world economies currently report expansionary conditions.
However, GSAM added that it is closely monitoring ongoing trade negotiations and elevated risk from higher interest rates in the US, both of which are headwinds for the asset class.
Meanwhile, public pensions’ strategic allocation changes involving fixed income were “all over the board,” according to GSAM. Some plans reduced their exposure to investment grade and longer-duration instruments, while others increased allocations to emerging market debt, Treasury Inflation-Protected Securities (TIPS), and shorter-duration fixed income.
“As plans contemplate the composition of their fixed income allocations, many are grappling with the competing forces of Fed tightening, potentially higher inflation in the future, liquidity needs for benefit payments and the need to find incremental return,” said GSAM.
The report also said that while the market expects a total of two rate hikes in the next two years, GSAM expects three rate hikes in 2019 alone.