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Asset owners, managers see different challenges on investment horizon

Vicki Fuller, chief investment officer of New York State Common Retirement Fund, said ‘We’re battening down the hatches.

Institutional investors and alternative investment managers appear to have different ideas of what is important for the future, if comments of general partners and limited partners speaking on different panels at the Milken Institute Global Conference are a guide.

Institutional investors are concerned that the world is fairly valued and this is not a time to invest in risky strategies. Investors seemed more concerned than managers that the $1.8 trillion in dry powder for alternative investments could lead to higher prices and lower returns.

The world right now is living in a "Goldilocks economy" with growth and inflation not too hot and not too cold, said Christopher J. Ailman, chief investment officer of the $222.5 billion California State Teachers' Retirement System, told attendees at the conference, held April 30 to May 2 in Beverly Hills, Calif.

"If anything, we're a little defensive. We're not going to take a lot of risk in the portfolio at this time because things don't look cheap," said Mr. Ailman, speaking on a panel on "Institutional Investors: Focusing on Long-Term Value in a Short-Term World."

About a third of CalSTRS' portfolio is invested in illiquid assets and even illiquid investments are "priced to perfection," he said.

Vicki Fuller, CIO of the $209.1 billion New York State Common Retirement Fund, speaking on the same panel, said this is not a time to take chances with a portfolio.

"We're battening down the hatches," Ms. Fuller said. "We're trying not to be too cute."

For example, over the past several years the pension fund has moved its real estate portfolio into core and core-plus strategies from being overweight in opportunistic ones before the financial crisis, she said. Pension officials also are upgrading the credit quality of the fixed-income portfolio.

Some investors and others speaking during the three-day conference noted there is a lot of capital aimed at alternative investments, and that could make it harder to gain superior returns from those asset classes.

During a panel titled "Institutional Investors: Thriving Amid Change," Dilhan Pillay Sandrasegara, deputy CEO of Temasek International, the wholly owned management arm of Singapore's sovereign wealth fund, Temasek Holdings, noted that in alternative investments, "there's a lot of liquidity out looking for investments to make."

In addition to sovereign wealth funds, there are family offices looking to invest. "Competition for good quality assets has intensified," Mr. Sandrasegara said.

Raphael Arndt, CIO of Australia's Future Fund, speaking on the same panel as Mr. Sandrasegara, said executives at the A$141 billion ($106.2 billion) sovereign wealth fund expect growth for the portfolio in the near term but are more pessimistic long term. So Future Fund executives expect to diversify away from equities, its riskiest asset, into hedge funds — which can be defensive in adverse market scenarios — and early stage venture capital, which can succeed without market growth, Mr. Arndt said.

Despite the caution of the asset owners, managers seemed to expect to continue to find lucrative investment opportunities and to have little trouble raising capital.

Alternatives have been the best performing asset classes, said Leon Black, chairman, CEO and director of Apollo Global Management, speaking on a panel, "Global Private Equity Outlook." Private equity has a better alignment of interest "than any other asset class," he said, noting Apollo charges 1.25% management fees and 20% carried interest after an 8% minimum return.

While the world is "awash in capital," Mr. Black said the roughly $1.8 trillion in dry powder is "irrelevant." It comes down to the manager's strategy and if the manager will be able to outperform the public markets, he said.

It's a time of "high anxiety" among institutional investors, said Jonathan Sokoloff, managing partner of private equity firm Leonard Green & Partners who spoke on the same panel as Mr. Black.

But Mr. Sokoloff said he "never worries about dry powder" because his firm's returns are good.

Leonard Green & Partners has benefited from multiple expansion — being able to sell a company for a higher price relative to its net income than the firm paid for it. "I worry how much that will continue," Mr. Sokoloff said.

Although no one can predict the future, private equity will continue to deliver the highest returns of any asset, which is why money is flowing into the asset class now, he added.

Some of the capital is from new investors, many from outside the U.S. "because the returns have been great," Mr. Sokoloff said.

Since investors have "wised up" and cut their rosters of managers, investing more money with fewer managers, the top firms are getting most of the capital, Mr. Black said.

Bruce Flatt, CEO of real asset management firm Brookfield Asset Management Inc., speaking on the panel with Messrs. Black and Sokoloff, said that the general partners with the best returns are getting most of the capital.

Russell Read, CIO for the $64.5 billion Alaska Permanent Fund Corp., said the sovereign wealth fund is only investing in private equity firms that invest in companies that would be disruptive in their sectors.

Alaska Permanent is changing the way it approaches the alternative investment asset classes, he said. Rather than committing capital to commingled funds to be invested solely at the manager's discretion, Alaska Permanent officials prefer partnering with other asset owners or managers, Mr. Read said. He spoke on the same panel as Messrs Arndt and Sandrasegara.

And some investors have new capital to invest in alternatives.

Tokihiko Shimizu, CEO of Japan Post Investment Corp., a joint venture of Japan Post Bank Co. and Japan Post Insurance Co., with a combined 285 trillion ($2.6 trillion), have allocated $60 billion to private equity, infrastructure and real estate. The joint venture, announced in February, will use direct investments in the private equity allocation, Mr. Shimizu said. It will focus on disruptive technologies including machine learning and blockchain that "will make the world better," he said.