Government bonds and equities have long served as a cornerstone of pension fund portfolios.
While these traditional asset classes have their merits, they represent an uncomfortably high (and growing) percentage of pension portfolios, leaving them vulnerable to concentration risk and the underperformance in these two asset classes.
The Nairobi Securities Exchange (NSE) All Share Index, for example, fell by 27.7 percent in 2023 and bond valuations have taken a beating following recent rises in interest rates.
Driven by this high concentration risk, heightened market volatility, and the threat of inflation, pension funds are increasingly exploring diversification strategies beyond traditional assets to protect member funds, and alternative assets such as infrastructure, REITs, private equity and private credit make a well-justified addition to pension fund portfolios.
While not without risk, alternative assets have a lower correlation with traditional markets and complement existing equity and bond holdings.
Strategically diversifying portfolios with these assets results in improved risk-adjusted returns and more robust and resilient portfolios, better equipped to weather unforeseen economic challenges and market fluctuations.
The Retirement Benefits Authority (RBA)’s investment guidelines permit pension funds to allocate portions of their investments to alternative assets, underscoring the regulator’s recognition of these investments’ role in a balanced and forward-looking investment strategy.
The RBA allows for up to 10 percent investment in infrastructure and private equity each, and 30 percent in REITs, facilitating a broad spectrum of investment opportunities.
While the regulatory framework is conducive and the need for diversification clear, it cannot be overstated that pension schemes are conservative investors (and rightfully so) whose primary goal is to protect and grow the pensions of hard-working contributors.
The means of investing in traditional assets are well understood, and products such as money market funds are widely available. Alternative assets are, however, less familiar and the question remains: how can pension funds expand their investment menu?
Pension funds can approach alternative investments from several angles. One option is investing through dedicated funds specifically focused on alternative assets.
These dedicated funds offer ease of access to a large number of opportunities through a single investment, and allow pension funds to benefit from the specialised expertise of the fund managers who bring to the table a deep understanding of specific asset classes, enhancing the pension fund’s ability to navigate the alternative investment landscape successfully.
Direct investments are a further option and the use of capital market instruments such as bonds and REITs provide the means to pool significant amounts of capital from multiple investors into areas such as infrastructure and can provide the much-needed liquidity and pricing transparency.
Further, direct investments allow for co-investments with other investors providing access to opportunities that might have been previously unavailable while also benefiting from economies of scale through shared expertise in areas such as investment due diligence which can often be pricey.
In light of these considerations, it is evident that the strategic allocation to alternative assets represents a prudent approach to investment, one that balances the pursuit of higher returns with the imperative of portfolio diversification, and this less travelled road need not be daunting as the expertise to explore these opportunities is readily available and aligned to the commitment to the long-term security of pension portfolios.
The writer is the Managing Director, Spearhead Africa.