Top investment issues facing U.S. pension plan sponsors include whether to invest internationally, the role of alternative investments and hedge funds, re-evaluating fixed-income strategies and the role of currency in investment returns, according to a new study by Putnam Investments, Boston.
The report targeted a list of 90 Putnam clients and prospects, of which 39 plans with more than $1.1 trillion in combined assets participated - nine public funds, 23 corporate pension plans and seven endowments and foundations. Twenty-six participating plans had assets of more than $10 billion each; 13 had assets of less than $10 billion each.
"The question of `why international equities' is on everybody's mind," said Jeffrey B. Saef, senior vice president and head of the Putnam's strategic relationship team. None of the pension plans in the survey had more than a 20% commitment to international equities, with a couple of the funds recently reducing their international exposure to around 19%, from 25%.
The poor performance of international equities over the last couple of years concerns sponsors, as does the level of diversification international investing actually provides, the report showed. The possibility of moving from a passive MSCI Europe Australasia Far East index to an active EAFE mandate is also on plan sponsors' minds. Mr. Saef said that while EAFE has been a poor performer over the last couple of years, causing plan sponsors' some concern, "many active (EAFE) managers have outperformed the index" and had less correlation to domestic U.S. equities, causing plan sponsors to consider moving from a passive EAFE mandate to an active mandate.
Plan sponsors also are concerned about how much to invest in alternative investments and are interested in more active products, particularly hedge funds, according to the report. Public pension funds particularly are concerned about hedge funds' place in their asset mix. There is also a general concern that too much money is already chasing hedge funds. "There could be more market demand (for hedge funds) than there is high-quality capacity," meaning there aren't enough hedge funds with successful track records to absorb all the money.
There is also concern about the "dwindling alpha pool" for absolute-return funds and the resources and infrastructure that are required to invest in hedge funds. The choice to use funds of funds and high hedge fund fees are also important to plan sponsors.
The plan sponsors in the survey had an average of 8% of their total assets invested in private equity, with allocations ranging from zero to 22%, and 7% in real estate, with allocations ranging from 1% to 20%.
For fixed-income investments, plan sponsors in the survey are concerned over whether than should maintain a core plus exposure or use a core plus satellite investment approach. Structuring a fixed-income plan given the low interest rate environment and the risk of deflation are also concerns of plan sponsors. The report also noted there was no mention of the Lehman Universal Index by the pension funds interviewed, with only limited interest in assuming more risk than is in the Lehman Aggregate Bond Index.
The question of when and how to hedge pension funds' currency risk is considered important. Mr. Saef said the possibility of a falling U.S. dollar was on the minds of plan sponsors. He said that all the plans in the survey hedged their currency exposure and several were thinking of hiring a currency overlay manager.
Other results showed:
* Six of the large pension plans in the survey had from a 1% to a 7% allocation to global equities, Mr. Safe said, but they are concerned about finding the right benchmarks and actually going from "concept" to "practice" in the global arena.
* Sponsors also are concerned about using the Morgan Stanley Capital International All-Country World Index ex-US for emerging markets exposure or a separate emerging markets mandate. While there was increased use of the ACWI ex-US benchmark. Mr. Saef said emerging markets' strong investment performance over the last two quarters has sparked a renewed interest in dedicated emerging markets mandates.
* Sponsors are concerned over how best to make their asset allocation decisions. Many funds also are revisiting policies on rebalancing, including whether it should be done annually or based on risk.