Infrastructure, energy rise to the top of pension fund alts portfolios

Infrastructure and energy investments had the most growth among the alternative asset categories in investors' portfolios in the 12 months ended Sept. 30, albeit from small bases, the results of Pensions & Investments' largest U.S. retirement plans survey show.

Infrastructure assets were up 50.6% to $12.8 billion, surpassing the year-earlier survey's 6% growth rate.

Growth slowed in both of the previous survey's highest flying alternative investment asset classes — energy and distressed debt. Although energy was up 45.4% to $17.3 billion, that was down from the 59% growth in the year-earlier survey, while distressed debt assets declined 2.8% to $24.7 billion.

Real estate investment trust assets rose 12.6% to $23.3 billion, rebounding from the 7.58% drop in the year ended Sept. 30, 2013. The REIT growth rate also topped that of real estate equity, which was up 9% to $283.1 billion. (Real estate equity had increased 10.5% in the previous survey.)

Real estate equity and REIT assets both were buoyed by returns. For the 12 months ended Sept. 30, the NCREIF Property index was up 11.3% and the NCREIF Open-end Diversified Core Equity index return was 11.36%, net of fees. The FTSE NAREIT All REITs index was up 13.44% during the survey period, and the FTSE NAREIT All Equity REITs index returned 13.17%.

Among other alternatives investment asset classes, commodities investment rose 9.9% to $25.5 billion in the 12 months, and overall hedge fund assets grew 5.7% to $158.5 billion. (That hedge fund total however reflected double-digit growth in direct investment and a double-digit decrease in funds of funds.) Private equity increased 7.4% to $337.2 billion.

Low interest rates put a damper on outperformance, said Sanjay R. Mansukhani, senior manager research consultant in the New York office of Towers Watson Investment Services Inc., a subsidiary of Towers Watson & Co.

“In general volatility was low, and low volatility sets the stage for returns being more correlated across different asset classes,” Mr. Mansukhani said. “There's less scope for outperformance in an environment of low volatility. When volatility starts to go up, then investors have a clearer sense of winners and losers.”

Higher returns would have helped to boost assets.

Investors that had considered pulling back from private equity at the beginning of 2014 to reduce illiquidity in their portfolios kept their target allocations the same, he said. The reason is that distributions started rolling in because private equity managers sold off their holdings as valuations began to rise and interest rates remained at extremely low levels.

“Because they were getting a record number of distributions from their private equity managers, they (investors) were willing to reinvest in the asset class,'” Mr. Mansukhani said. ”They didn't make ... increased allocations but they did reinvest in the assets in the private equity.”

Indeed, the aggregate allocation to private equity among defined benefit plans in the top 200 stayed relatively flat at 8.7%, dipping from 8.9% a year earlier. Real estate was also about the same, at 7.2% vs. 7.3%.

Cambridge Associates LLC U.S. Private Equity index return for the year ended Sept. 30 was 18.09%, trailing the Standard & Poor's 500 index return of 19.73%.

The five top defined benefit investors in private equity held their positions from a year earlier, with assets dipping for the top two — the California Public Employees' Retirement System, Sacramento, and the California State Teachers' Retirement System, West Sacramento — and increasing for the remaining three.

CalPERS' private equity assets dipped 0.2% to $31.25 billion; CalSTRS' dropped 1.75% to $21.44 billion. Meanwhile, at the Washington State Investment Board, Olympia, private equity assets were up 9.2% to $16.42 billion; Teacher Retirement System of Texas, Austin, up 7.5% to $15.42 billion; and the Oregon Public Employees Retirement Fund, Salem, up 7.8% to $15.09 billion.

Investors were committing massive amounts of capital to infrastructure during the survey period, with the average size of a fund closing as of Sept. 30 rising to more than $1 billion from $697 million in 2013, according to London-based alternative investment research firm Preqin.

There is a big crossover between infrastructure and energy. Four of Preqin's top five infrastructure deals as of Sept. 30 involved energy.

However, fundraising for energy funds began to slow during the survey period. In the first eight months of 2014, 15 North America-focused private equity funds targeting the oil and gas industries, either exclusively or as part of a wider industry focus, closed on a total of $8 billion. By comparison, funds focusing on oil and gas raised $29 billion in all of 2013, Preqin data shows

“The increase in infrastructure and energy (commitments by institutional investors) are a reflection of the growing and continued interest we've seen in real assets more broadly over the last few years,” said Peter Rogers, senior investment consultant in Towers Watson's New York office in an e-mail.

“The increase could be due to investors coming out of the j-curve from increasing allocations to infrastructure or real assets more broadly and making commitments two to four years ago,” he said.

What's more, the growing investor interest in direct investments and co-investments has given investors the ability to increase invested capital, Mr. Rogers wrote.

The top three energy investors in P&I's universe all reported increases in their portfolios. The Pennsylvania Public School Employees' Retirement System, Harrisburg, boosted its energy portfolio 43% to $2.1 billion; the Minnesota State Board of Investment, St. Paul, up 10.7% to $1.25 billion; and the Teachers' Retirement System of Oklahoma, Oklahoma City, had the most dramatic growth of the three with energy assets up 58.7% to $1.19 billion.

“There's been a lot of fundraising and several large investments made across Western Europe and the U.S in energy,” said Brandon Prater, London-based partner and global co-head of private infrastructure at alternative money manager Partners Group.

Infrastructure's popularity didn't surprise Mr. Prater because the asset class is perceived to be in the safer end of the risk-return spectrum; it is asset-backed, essential and generally should have lower volatility, he said.

Within hedge funds, the gulf between direct investment and funds of funds widened as direct investments grew 12.23% to $129.4 billion and fund-of-funds assets fell 16.1% to $29.1 billion.

What's more, some investors have been questioning being in hedge funds at all. CalPERS began paring its $5.3 billion hedge fund portfolio early in 2014, but shocked the investment world when it announced Sept. 15 it would be eliminating its remaining $4 billion portfolio.

“There's a scarlet letter on hedge funds because of the media coverage of CalPERS” exiting the asset class, said Jonathan Grabel, chief investment officer of the Public Employees Retirement Association of New Mexico, Santa Fe. In April, New Mexico PERA reduced its hedge fund allocation to 4% from 7%. Pension plan officials are now in the process of implementing that decision.

At New Mexico PERA, officials are cutting their hedge fund allocation to better diversify risks across investment strategies, Mr. Grabel said. The reduction is also a recognition that hedge funds might be a better strategy for investing in other asset classes rather than an asset class itself, he explained. Officials now are in the process of deciding how to implement the changes.

The top three hedge fund investors in P&I's ranking held onto their top spots. Texas Teachers, with $11.8 billion, is up 11% from a year earlier; the New Jersey Division of Investment, Trenton, which manages investments for the New Jersey Pension Fund, saw a 20.2% increase to $9 billion; and Pennsylvania Public School Employees, up 22% to $8 billion.