Private credit, infrastructure lead pack with double-digit increases

Investor views of some alternative investments altered by the COVID-19 crisis and persistent low interest rates appear to have affected the holdings of the 200 largest retirement plans in Pensions & Investments' annual survey.

Aside from private credit assets, which nearly doubled in the 12 months ended Sept. 30, the asset class with the largest increase was infrastructure, up 21.5% to $41.3 billion.

But compared to infrastructure, other real asset sectors languished, with real estate equity eking out a 4% increase to $369 billion, real estate investment trusts down 19.8% to $28 billion, and energy dropping 21.8% to $24.1 billion.

"Clients swapped out listed infrastructure or REITs for something more direct in nature such as infrastructure," said John Delaney, Philadelphia-based senior director, investments at Willis Towers Watson PLC.

However, when viewed over longer time horizons, both real estate sectors witnessed big increases, but not as much as infrastructure. Real estate assets of the top 200 retirement plans are up 22.7% over the five-year period and 119.6% over the 10 years ended Sept. 30. REITs are up 19.7% for the five years and up 24.4% over the 10-year period. Infrastructure rose 147.3% for the five years and 709.8% for the 10 years ended Sept. 30, from a base of only $5.1 billion in 2010.

Institutional investors were especially interested with infrastructure with a green or environmental, social and corporate governance tilt, Mr. Delaney said.

At the same time, there was a lot of concern among investors about the future of real estate, he said.

REITs are publicly traded and easily accessible and were a place where investors could get liquidity in the first half of 2020, he said.

"REITs probably sold potentially more than they should have," Mr. Delaney said. But the price movement indicated investors expected a "pretty dire future for REITs going forward," he said.

In the year ended Sept. 30, the FTSE Nareit All REITs return was -13.3% and the FTSE Nareit All Equity REITs was -12.15%.

During the 12-month period ended Sept. 30, a number of the retirement plans in this year's survey cut or liquidated their REIT exposure. Among them were:

• $38.6 billion Indiana Public Retirement System, Indianapolis, which cut its REIT portfolio 50.3% to $86 million.
• $23.5 billion Illinois State Universities Retirement System, Champaign, eliminated its $373 million REIT allocation.
• $225.4 billion New York City Retirement Systems sold off REITs in 2020, down to $449 million from $1.5 billion the year before.

Meanwhile, transactions in the plain-vanilla real estate equity sectors such as office, hotels, multifamily and retail fell due to the pandemic, Mr. Delaney said.

There's a fair amount of uncertainty around the future of offices and hotels, Mr. Delaney said. "It's hard to know long term how the rollout of the vaccines will play out and what it will take for people to feel comfortable staying in a hotel or going back to work at an office."

"We're not looking to overweight or add a lot of investment in those areas, but we don't think they should be completely ignored in terms of their long-term potential," he said.

Willis Towers Watson has been recommending that clients increase their investments to essential service sectors such as warehouses nursing homes, logistics and data centers, he said.

All but one of the top five real estate equity investors had positive growth during the 12-month period. The $426.2 billion California Public Employees' Retirement System, Sacramento, was in the top position on P&I list of the largest investors in real estate equity with assets up 19.7% to $44.4 billion. Nearly 90% of CalPERS' real estate portfolio is in core real estate, with all of the core portfolio in separately managed accounts, according to the pension plan's latest semiannual report. CalPERS has been reducing its legacy, non-core portfolio and increasing its exposure to core stabilized real estate. In 2016, 55% of CalPERS portfolio was in core.

The $259.2 billion California State Teachers' Retirement System, West Sacramento, in second place, saw its real estate assets grow by 5% to $35.7 billion. In July, CalSTRS moved its asset allocation closer to the long-term targets adopted in January, increasing its private equity and real estate allocations, which due to the coronavirus pandemic were a larger percentage of its asset mix because of equity market volatility. Each asset class was boosted by 1 percentage point to 10% and 14%, respectively.

Rounding out the top five in real estate are the $162.7 billion Texas Teacher Retirement System, Austin, up 2.75% to $22.2 billion in the third position. TRS staff planned to commit $4.2 billion in 2020, with 50% of the total going into co-investments. By comparison, the pension plan had invested $6.2 billion in real estate in 2019.

Next were the $128.9 billion Washington State Investment Board, Olympia, up 3.2% to $19 billion, and the $226.4 billion New York State Common Retirement Fund, Albany, down 3% to $16 billion in real estate.

A 4-percentage-point drop in returns for the 12-month period was a factor in this year's results. The NCRIEF Open-end Diversified Core Equity index gross of fees total return was 1.39% for the year ended Sept. 30, down from 5.59% over the previous year. The return for the period was also less than the ODCE's five-year annualized return of 6.64%.

Among the other alternative investment sectors tracked by P&I, private equity rose 9.6% in the year ended Sept. 30 to $438.5 billion, with buyouts up 17.8% to $258.3 billion and venture capital up 5.6% to $45.4 billion.

Private equity generally offers returns more than public equity market, which is important to investors when fixed-income returns are so low, WTW's Mr. Delaney said.

What's more, public equities are fairly concentrated, and thus, more risky with the stock markets moving along with five companies on a given day," Mr. Delaney said. "You're reliant on the success of the FAANG (Facebook Inc., Amazon.com Inc, Netflix inc, Apple Inc and Alphabet Inc.) stocks. If you're trying to generate equity-like returns, private equity looks attractive and removes the concentration risk," he added.

But there are risks to investing in the asset class.

Whether you are investing in venture capital or leveraged buyouts, one risk is that the companies you are buying are unproven commodities and could become distressed, he said. Investors also need to be compensated for the illiquidity risk they are taking compared to public equities, Mr. Delaney added.

CalPERS is also in the top position on P&I's private equity list, with assets up 6.9% to $28.1 billion.

At a Jan. 20 stakeholder forum, interim CIO Dan Bienvenue noted that CalPERS is underweight its 8% policy target to private equity, which is one of the fund's "arrows in its quiver" to attain its 7% expected rate of return.

"Candidly, we have been inconsistent in how we deployed" to private equity, he said. Investing more capital in private equity is a focus of the private equity team, Mr. Bienvenue said. He acknowledged the risks of private equity compared to stocks are illiquidity in having capital locked up for 10 years or more and higher costs than public equities.

Also impacting CalPERS' results is that its private equity portfolio underperformed its benchmark by 93 basis points to a net return of 2.3% in the year ended Sept. 30. Over the three years, it underperformed its benchmark by 98 basis points to a net return of 7.2%; by 152 basis points to a net return of 7.8% in the five-year period; and 226 basis points of underperformance to a net return of 11.3% in the 10-year period, according to a November report to the investment committee.