Survey: Public plans tops in increasing allocations

Public pension plans are giving endowments and foundations a run for their money in alternative investing, according to a preview of a J.P. Morgan Asset Management report that shows state and local plans will outpace other institutional investors in increasing their allocations.

Public pension plans will have an average 21% allocation over the next two to three years, seven percentage points above the 14% average in the first quarter 2009, according to the report, “Market Pulse — Alternative Assets,” from the New York-based money manager.

Meanwhile, endowments and foundations expect to boost their allocations by an average five percentage points, to 31%, from the 26% average allocation as of Dec. 31, 2009. Corporate pension plans are expected to increase their average allocation by three percentage points, to 14%, over the same time period.

Despite the heavy losses suffered by endowments and foundations in the credit crisis, because of highly leveraged positions and large investments in alternatives, the report's authors say the endowment model for investing “appears alive and well.”

Among all funds surveyed for the report, 56% plan to increase funding to alternatives, 31% expect to maintain investment at existing levels and 13% planning to reduce allocations.

John Hunt, CEO, U.S. institutional, at J.P. Morgan Asset Management, said in a telephone interview that the credit crisis increased foundations' and endowments' awareness of liquidity issues, but it didn't make them turn away from alternatives.

“They probably came out (of the credit crisis) better risk managers,” he said.

Corporate plans are being held back by funding requirements set out in the 2006 Pension Protection Act, Mr. Hunt noted, leading them to increase positions and durations in fixed income to match assets with liabilities. Public plans, not subjected to PPA requirements, have focused more on making up losses suffered in the credit crisis, he said.

“Public plans are more focused on return generation, so they've increased their allocation to alternatives; the survey bears that out,” Mr. Hunt said.

The survey's results mirror those of a Greenwich Associates study released in March that showed corporate plans are shedding risk in preparation for higher cash contributions mandated by the PPA, while public plans make a “swing-for-the-fences” attempt to close funding shortfalls.

“There's clearly a derisking going on that's continued despite the fact that, because of the historically low levels of interest rates and the decline in market values, corporate pension funds are substantially underfunded,” Greenwich analyst Chris McNickle told Pensions & Investments in a story published on March 8. “And that implies a willingness or acknowledgment that they're going to have to make contributions (to become fully funded.)

“Public funds are going in a different direction. They've got huge (funding) gaps and they're trying to make that up by excess returns.”

Seventeen percent of public pension funds in the Greenwich study plan to reduce fixed-income allocations significantly over the next two to three years, while 23% plan increases in private equity and by 2012 and 18% plan to significantly increase hedge fund allocations.

The survey also showed that with quantity comes quality — institutional investors are seeking greater diversification within alternatives such as infrastructure, real assets and commodities, along with expanding their overall allocation.

Sixty-one percent of survey respondents are currently invested in real, and 8% of all survey respondents said they plan to make new investments in the asset class. Fifty-two percent of all survey respondents are currently invested in private equity and 46% are invested in hedge funds. Eight percent of all survey respondents said they plan to invest in private equity and another 8% plan to invest in hedge funds.

Nine percent of survey respondents are invested in infrastructure, and another 9% plan to add infrastructure holdings; 16% are in commodities, and another 10% plan to add the asset class; and 17% are in real assets, while another 5% plan to add real asset holdings, according to the survey.

Hedge funds and real estate were the two most popular asset classes as the best alternatives investment opportunities in the next three to five years, with 24% of survey respondents saying each provide the best opportunity. Private equity was a close third at 21%, followed by commodities at 16%, infrastructure at 9% and other real assets at 6%.

Investors surveyed by J.P. Morgan strongly preferred Asia-Pacific over other regions for investing in alternatives, with 56% of respondents saying it holds the best opportunity. North America followed at 37%, with Europe trailing at 3% and “other countries” making up the remainder.

“People recognize the growth (in alternatives) in the region,” Karin Franceries, vice president, strategic investment advisory group, J.P. Morgan Asset Management, said in a telephone interview.

Although getting access to the region can be more difficult and entail greater risk, Ms. Franceries said alternatives asset managers in the region can provide the opportunity to outperform public markets.

Survey respondents pointed specifically to private equity as an investment opportunity in the Asia Pacific region. Respondents who invest in private equity said about 10% of their allocations are in the region, but that is expected to increase by five percentage points over the next year.

Investors who have infrastructure allocations planned to double their Asia Pacific investments in the strategy to 12% in the next 12 months.

Tim Friedman, a spokesman for London-based alternative investment research firm Preqin, said in a telephone interview that Preqin's data don't show a big private equity shift toward Asia Pacific and away from Europe and the U.S. He did add, however, that Preqin is seeing renewed interest in hedge funds and private equity in general.

Private equity funds prior to the 2008 credit crisis were highly leveraged, and investor confidence was shaken when the deals fell apart.

However, in a later e-mail response to questions, Mr. Friedman said Asia Pacific is the most popular region for private equity within emerging markets, “with 56% of rest-of-world investors seeing the region as presenting the best opportunities.”

While the J.P. Morgan survey numbers show a renewed commitment to alternatives, the survey's authors said that anecdotally they are hearing that their clients are re-examining pre-crisis target allocations overall to better understand alpha, beta and liquidity risk associated with their investments.

“Investors are beginning to think more holistically about their portfolios — viewing hedge fund investments, for example, as a less liquid, unconstrained extension of traditional equity and fixed-income allocations,” according to the report. “In their open-ended survey responses, we see a desire to: better understand 'total plan characteristics and risk' and the economic sensitivities of individual investments; to 'incorporate liquidity into asset allocation models,' and to manage 'downside' or 'left-tail' risk.”

The survey of 349 North American investors from 325 institutions by J.P. Morgan was conducted in March and April. The complete survey results will be issued later this summer.