Retirement plans still showing lots of love for non-traditional asset classes

Most alternative investment asset classes — both in U.S. defined contribution and defined benefit plans — realized stunning asset increases in the year ended Sept. 30, according to the findings of Pensions & Investments' Top 200 retirement plan survey.

Defined contribution plan assets in commodities, Treasury inflation-protected securities and real estate investment trusts — the three stand-alone alternative investment categories tracked by P&I in DC plans — grew substantially compared with the year-earlier survey. REITs were up 44% to $3.6 billion, TIPS grew 19% to $8.7 billion and commodities rose 60% to $800 million. However, much of the alternative investments in defined contribution plans are contained in target-date funds. (See related story above.)

Growth of REITs, TIPS and commodities was on overdrive compared with P&I's year-earlier survey. REIT assets for defined contribution plans in the top 200 dipped less than 1% in the year-earlier survey, while TIPS rose 7% and commodities grew 21%.

Among defined benefit plans in the top 200, many alternative investment asset classes continued the double-digit rise exhibited in the year-earlier survey. Equity real estate rose 11% to $235.1 billion; commodities rose 20% to $24.7 billion; REITs were up 30% to $22.4 billion; infrastructure was up 25% to $8 billion; and energy jumped 67% to $7.5 billion.

Growth in equity real estate, REITs and commodities were boosted by strong returns during the survey period. For the 12 months ended Sept. 30, the NCREIF Property index was up 11%, the FTSE NAREIT All REITs index was up 34.37% and the FTSE NAREIT All Equity REITs index was up 33.81%. The Dow Jones-UBS Commodity Index Total Return index was up 5.99% in the period.

Private equity investment in defined benefit plans was the sole exception to the growth story, dipping less than 1% to $310.6 billion. Venture capital dipped 1.7% to $34.2 billion, while buyouts rose 4.6% to $179.3 billion. Private equity's share of the DB plan assets in the top 200 was down 60 basis points to 9.4%.

The scenario is quite different from the previous year's survey, which showed a 16% increase in private equity, a 26% increase in venture capital and a 15% jump in buyout assets.

Industry insiders say the decrease could be explained by increased distributions some investors received in the third quarter of 2012.

“It was a pretty robust third and fourth quarter for distributions for investors with mature private equity programs. Pantheon had record levels of distribution activity,” said Susan Long McAndrews, San Francisco-based partner, and head of U.S. primary investments of global private equity investment firm Pantheon Ventures.

Ms. McAndrews leads Pantheon's North American primary fund investment activity.

According to preliminary data from Cambridge Associates LLC, distributions from U.S. private equity funds rose 11% to $20.4 billion in the third quarter.

“I have not seen our clients cutting back on private equity,” said Bradley Morrow, a New York-based senior private markets consultant for Towers Watson Investment Services Inc., a research subsidiary of Towers Watson & Co. Investors have not added to their private equity allocations, but they have not been cutting back either, he said. Instead, some investors are creating new allocations to investments they once considered subsets of private equity.

“I have noticed that as time goes by, some investors are more comfortable with energy and infrastructure and have started classifying them in a different way,” Mr. Morrow said.

Some of the largest pension funds made moves during the survey period to expand their infrastructure investments. Some 142 infrastructure funds worldwide raised $91.6 billion as of Oct. 1, according to London-based alternative investment research firm Preqin.

The California Public Employees' Retirement System, Sacramento, held a series of closed-door meetings with industry executives as part of its move to invest $800 million in California infrastructure. The $253.2 billion system has a 2% target allocation to infrastructure, but a lack of suitable investments had limited investments to about 1% of the retirement system's assets.

CalPERS is ranked second on P&I's list of DB plan infrastructure investors, with $1.04 billion invested as of Sept. 30, just behind top-ranked Western Conference of Teamsters Pension Trust, Seattle, with $1.33 billion.

The $154.3 billion California State Teachers' Retirement System, West Sacramento, last February made what it said was one of the largest single U.S. infrastructure investments, committing up to $500 million with Industry Funds Management for a diversified portfolio of core infrastructure assets in North America and Europe. CalSTRS is 23rd on P&I's infrastructure list, with $56 million invested in infrastructure as of Sept. 30.

The $9.8 billion New Mexico Educational Retirement Board, Santa Fe, which is 19th on P&I's infrastructure list, last April added an allocation to direct co-investments within its $102 million infrastructure portfolio.

“In the last six months, we've seen a tangible and noticeable new allocation to infrastructure” by U.S. investors, said Mark Weisdorf, CEO of infrastructure investments at New York-based J.P. Morgan Asset Management. J.P. Morgan estimates more than $2 billion in new allocations to infrastructure during the second half of 2012, Mr. Weisdorf said.

Institutions also made additional commitments to energy funds during the 12-month survey period, such as the Minnesota State Board of Investment, St. Paul, which is at the top of P&I's list of pension funds with the most energy investments. And those moves have continued. In December, the Minnesota board committed $100 million to EnCap Energy Capital Fund IX, managed by EnCap Investments LLC.

Defined benefit investors continued to invest in equity real estate but moved to slightly less stable properties in second-tier locations because core properties were fully priced, said Peter A. Lewis, senior consultant in the New York office of Towers Watson Investment Services.

A growing number of money managers have been marketing direct real estate investments for defined contribution plans, mostly through target-date funds. REITs, on the other hand are becoming an established DC plan investment option.

Defined contribution participants have been drawn to REITs as a way of boosting returns and diversifying portfolios, said Dave Esrig, managing director and portfolio manager for J.P. Morgan Asset Management.

International Business Machines Corp., Armonk, N.Y., was first on the list of defined contribution plans holding REITs, with $1.2 billion, followed by Verizon Corp., Basking Ridge, N.J., with $638 million and the Washington State Investment Board, Olympia, at $304 million.

“As a stand-alone option, REITs have enjoyed substantial allocations in recent years, partly because they have offered such excellent yield,” J.P. Morgan's Mr. Esrig said. “Participants have been aggressively looking for yield across their portfolios ... and the performance of REITs is very strong.”

A growing number of defined contribution plan executives and asset allocation fund providers are adding or increasing allocations to REITs, said Michael Grupe, executive vice president, research and investor outreach for the National Association of Real Estate Investment Trusts, Washington, in a written statement.

“Defined contribution plan sponsors and, increasingly, target-date fund providers are recognizing the potential investment benefits REITs can provide, in terms of income, long-term capital appreciation and inflation protection,” Mr. Grupe said.