Ilmarinen warns that cracks are surfacing in alternatives

Alternative assets such as infrastructure and real estate have been a popular way for Nordic pension funds to pump up returns.

But the latest crisis just exposed how risky many corners of the asset class are, when liquidity suddenly dries up.

As the chief investment officer of Ilmarinen Mutual Pension Insurance Co., Mikko Mursula oversees about €46 billion ($52 billion) from his office in Helsinki. He says that "one of the key lessons" he just learned from the turmoil triggered by COVID-19 is "the importance of liquidity."

The panic that hit markets in March, when much of the global economy was shuttered to fight COVID-19, revealed that many institutional investors were dangerously short on liquidity after stocking up on alternative assets. And the returns they were getting weren't compensating them for the risk.

"In some subasset classes, you didn't earn enough of an illiquidity premium anymore," Mr. Mursula said.

In the years leading up to the latest crisis, pension funds had turned to alternative assets as a way to pick up extra returns, against a backdrop of ultra-low interest rates and expensive stocks. Alternatives aren't as easy to buy and sell as stocks and bonds, but for long-term investors like pension funds, that wasn't supposed to be a problem.

Mr. Mursula says the pressure on liquidity started to mount in March, and "there is not much you can do in the middle of a crisis like this."

Even "as a long-term investor, you need to make sure that you will be able to survive" such bouts of turmoil, he said.

With a liquidity shock like the one the industry just suffered, focus quickly shifted to regulatory solvency requirements. Mr. Mursula says institutional investors will now "be going through their liquidity (or illiquidity) levels more thoroughly after the crisis," after seeing how quickly things can turn.

Mr. Mursula will now try to insulate his portfolio from a potential second wave of infections and investor panic, which he says the market is "implicitly" currently "definitely not pricing in," but which represents "a high enough probability" to be a concern.

Mr. Mursula started to expand his presence in alternative assets last year. He still thinks they're a sound bet, provided they're properly managed.

Ilmarinen's portfolio lost 7.5% in the first quarter, with equity investments driving the plunge. The fund cut its stocks allocation to 42% from 47% at the end of the year, piling instead into more fixed income and alternative assets.

Mr. Mursula says he still needs "to have enough equity type of risk on board" to meet return targets. But it's an expensive bet.

"Some areas of the equity markets are looking a bit rich when compared to historical average valuation levels," he said. "Also, in those markets there are many investors who wouldn't be there if interest rate levels were a bit higher. That is because of the lack of alternatives."