This article first appeared in Personal Wealth, The Edge Malaysia Weekly, on Nov 23 - 29, 2015.

LARGE pension funds around the world are turning to non-traditional investments in their search for yield in the face of falling interest rates.

According to the Organisation for Economic Cooperation and Development’s (OECD) annual report, titled “Pension Markets in Focus 2015”, which was released on Nov 13, the shift to non-traditional or alternative investments is taking place in some of the largest pension markets in the world, such as Brazil, Canada, the UK and the US.

“Pension funds [in these countries] have diverted part of their traditional investments in bills, bonds or equities to alternative investments that could potentially bring higher returns, but also higher risks,” it says. The report looks at trends in the pension fund industry in OECD and selected non-OECD countries. 

In the light of the search for yield, the report suggests that regulators cap the amount on investments to avoid being overexposed to investment risks. “Most countries impose a ceiling on investments in alternative asset classes, but some of the largest pension funds do not.

“In addition, there seems to be a trend towards greater flexibility with regard to these asset classes, as more reporting countries loosened their restrictions on alternative asset classes than tightened them over the last 10 years.”

The report adds that it is essential for regulators and supervisors to monitor the extent to which “search for yield” may become a threat to pension systems. “Even pension funds that are decreasing their exposure to alternative asset classes may actually increase the risk profile of their portfolio if they invest in less secure forms of bonds or equities.”

These non-traditional investments include “land and buildings, real estate investment trusts (REITs), unallocated insurance contracts, various mutual funds, private equity funds, hedge funds, structured products and other investments, such as derivatives.”

“Countries that gave more room for pension funds to invest in alternative investments over the period of 2004 to 2014 outnumber those that did the opposite,” the report says.

Meanwhile, pension funds in some smaller markets have remained primarily invested in traditional instruments, such as equities, bills and bonds, in their search for higher returns. Five OECD and seven non-OECD countries increased their allocation in equities by more than 5% over the last decade.

“In Mexico, Norway and Poland, this trend could be partially explained by the loosening of the regulatory limit for equities that took place over the same period,” says the report. 

“And of these 12 countries, the increased allocation in equities coincided with a decreased allocation in bills and bonds in 10 countries, including Austria, Bulgaria, Colombia, Hong Kong and Luxembourg, suggesting a shift, at least partially, from bills and bonds to equities.

“In Romania and Liechtenstein, where pension fund investments in equities increased 18.4 percentage points between 2008 and 2014 and 7.2 percentage points between 2007 and 2014 respectively, the supervisory authorities confirmed that the recent increased interest in equities was a consequence of the low-yield environment.”

According to the report, the total value of private pension assets in the OECD was US$38 trillion (RM166.6 trillion) at end-2014. These assets are mainly managed by pension funds.

“Pension fund assets have grown by 8.1% yearly on average since end-2008. Over the last decade, the average growth rate has been lower but still positive, with a 5.5% yearly increase.

“The weighted average asset-to-GDP ratio for pension funds reached 84.4% in OECD countries and 36.4% in selected non-OECD countries at end-2014, with the Netherlands having the highest ratio at 159.3% of GDP.”

The report says pension funds remain the main financing vehicle of private pension plans, which include the managed funds of banks and 

management companies and pension insurance contracts. At end-2014, the assets under management of pension funds stood at US$25.2 trillion (compared with US$24.6 trillion in 2013), representing 66.8% of the total private pension assets in the OECD.

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