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Pensions Venture Into Risky Corners of the Market in Hunt for Returns

The Wall Street Journal. logo The Wall Street Journal. 5 days ago Avantika Chilkoti and Caitlin Ostroff
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Some pension-fund managers are venturing further into unusual investment territory as this year’s plunge in bond yields makes it even harder to find decent long-term returns.

Funds are dabbling in riskier asset classes, including private markets, real-estate projects, infrastructure financing and direct lending. Some are making riskier fixed-income bets, buying volatile assets such as 100-year Argentine government bonds. Others are going farther afield, investing in greenhouses and waste management.

“How do we get those types of return in an environment with low interest rates?” said Duncan Hale, a portfolio manager at Willis Towers Watson Investments, which offers insurance brokering, risk management and investment advisory services. He said he looks for tried-and-tested investment avenues that are “slightly outside of where you’ve seen pension funds usually invest.”

The giant pools of retirement money are under pressure to take on more risk following decades of declining interest rates that have chipped away at returns from their traditional bond-heavy portfolios. Those concerns have been exacerbated this year as yields on government bonds dropped sharply and central banks loosened monetary policy to stimulate economic growth.

Pension funds’ allocations to alternative asset classes rose to 26% in 2018 in the U.S., U.K., Japan, Australia, Canada, Switzerland and the Netherlands, from 19% in 2008, according to estimates from Thinking Ahead Institute, a research firm affiliated with Willis Towers. The allocation to bonds has remained steady at around 30%. That trend shows no sign of reversing, investors and analysts say.

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Falling bond yields hurt pensions by lowering a key metric called the discount rate, which measures the current value of a program’s future obligations to retirees. That forces the pensions to boost their assets to satisfy liabilities in coming years.

To help U.K. pensions generate steady returns, Willis Towers is advising its clients to invest in long-term property rental markets and infrastructure projects, as well as buying trains and leasing them to the government, according to Mr. Hale.

His fund backs a company that purchased land in eastern England for the construction of two greenhouses with a combined size of roughly 47 soccer pitches. Those will be leased out for 20 years to tomato growers and others, and are projected to generate annualized yields of more than 6% over the period.

Another project backed by the fund involves investing in a company that collects waste from London boroughs to be burned, helping generate electricity through turbines. Local authorities pay for the waste collection, while the electricity is sold back into the grid, according to Mr. Hale. The returns are expected to be more than 5% annually over 20 years, he said.

Some pension funds are moving into emerging-market debt—which can be volatile and sensitive to political headwinds—or less-liquid assets such as real estate.

One U.K. pension-fund client placed a sliver of its assets in the 100-year Argentine bond sold in 2017, according to Con Keating, head of research at Brighton Rock Group, an insurance provider for pensions. The bond currently offers a 27.712% yield, according to FactSet. In August, the value of those ultralong bonds fell by nearly half because of political uncertainty.

“This stuff really doesn’t belong in a pension fund,’’ said Mr. Keating. Because of the search for better returns, “you see all sorts of deals being done for all sorts of credit that wouldn’t ordinarily be touched,” he said.

The need to boost returns prompted Nest, a £8.5 billion ($10.9 billion) workplace-pension fund manager backed by the U.K. government, to make its first foray into private markets.

The firm is financing infrastructure projects such as toll roads and airports, and lending to commercial real-estate projects and buying collateralized mortgage-backed securities, through investments managed by Amundi SA and BlackRock Inc.

“It’s going to just become harder to eke out any returns from public markets,” said Stephen O’Neill, Nest’s head of private markets. With the new investments, “the main motivation is to try to pick up a private-credit premium—or liquidity premium—over the comparable bonds in the public market,” he said.

For pension funds in the Netherlands, the shrinking yields are a growing headache as they are required to surpass—and not just meet—estimated liabilities. Those that fall short must submit a recovery plan within a specified time frame.

APG, which has €440 billion ($486.9 billion) under management and oversees investments for the Netherlands’ largest pension fund for government and education employees, has less than 40% of its portfolio in fixed income, said Thijs Knaap, a senior strategist at the asset manager. Another 34% is in equities, 10% in real estate and 17% in alternative investment classes such as hedge funds and infrastructure. The firm, like many other pension funds, insurers and large investors, sees bonds as a crucial part of its portfolio because they can quickly be converted into cash, even if the returns are negligible.

“You have to work harder for your money,” said Mr. Knaap. “This means we’re taking on risk rather than the old situation of putting everything in bonds.”

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