The trend is clear. Pensions are increasing allocations to alternatives. What are the logical impacts of this trend?
by Pawel Rzeczkowski
I do not know the answer. However I do believe it is an important question to consider.
According to Willis Towers Watson, global multinational risk management, insurance brokerage and advisory company, the allocations to other (non-cash, non-stock non-bond) investments among US pensions has grown from 17% in 2006 to 27% in 2016. That is about 1% a year increase in allocations to mostly PE/Hedge Funds. The US Pensions size as of 2016 was $22.48 Trillion. Yes, Trillion!
From the PE/Hedge Fund industry perspective this is outstanding development! If we assume linear progression we are talking about $225 Billion in new AUM just last year.
If you talk to those PE/Hedge Funds you will find out that it is increasingly difficult to find “good” deals. Part of the reason for it has to do with the massive amount of money looking for those deals.
The Fed has lowered the federal funds rate to almost zero to stimulate the economy post the ’08 recession. The institutional investors that historically relied on annuities as part of their business had to adjust. Pensions are case and point. The increase in allocations to alternatives to cover the decline in returns from the bond and stock portfolio is the current drug of choice. Before it was shift to stocks from bonds.
At the macro level we are shifting the societal algorithm of capital allocation. Hence my original question. What are the logical implications of this allocation shift?
Is increased allocation to alternatives correlated with more investment dollars flowing into private vs. public companies? What does that mean?
What is the relation of the higher required returns of alternatives to the total system returns? Is the level of required return god proxy for risk in the system?
The trillion-dollar systemic question has to be if we are creating more wealth by shifting allocation to channels that requiring higher returns or are we just shifting the distribution of the aggregate wealth?
Do pension allocations even matter? As we have shifted from Defined Benefit (DB) to Defined Contribution (DC) should we be more focused on the allocations of all the Mutual Funds in all of our 401(k) plans? Or better yet, what investment system/wallet will rule the day after the 401k dies? What will be the impact on the financial services industry? What companies will be advantaged by that system yet to come into existence? Remember, the future is already here. It is just not evenly distributed.
We live in transformative times! We are moving past our industrial history into the unknown digital future. The resultant structural shifts in the economy are not very transparent. We see on the surface destruction of old industries and creation of billions in completely new fields. The last election in USA and Brexit in EU are some of the more visible testimonials that we miss the implications of it all. We miss it for the masses, for our institutions and for corporations. But the future is already here, embryos of the next BlackRock, of the next Vanguard are here! Who do you think they are?
Who will fund those new structures that will shape our financial future? Will they be shaped by the General Partners of the PE funds bolstered by the pension shifts to alternatives? Or will they fund growth by listing on public exchanges? Or via ICO?
I have no answers, though I am fascinated by the drama of it all playing out in front of us. We should ask more such questions as we are actively shaping this exciting transformation of out society and our organizations.