The world’s
100 largest alternative asset managers saw their assets rise 10% in 2016 to $4
trillion, according to Willis Towers Watson’s Global Alternatives Survey.
Among fund
types, pension funds hold 33% of alternative assets, followed by wealth
managers (15%), sovereign wealth funds (5%), endowments and foundations (2%),
banks (2%) and funds-of-funds (2%).
Real
estate accounts for 35%, or $1.4 trillion, of that total, followed by private
equity (18% and $695 billion), hedge funds (17% and $675 billion), private
equity funds-of-funds (12% and $492 billion), illiquid credit (9% and $360
billion), funds of hedge funds (6% and $228 billion) and infrastructure (4% and
$161 billion).
Among the
various alternative categories, illiquid credit saw the greatest increase in
assets in 2016, a 102% rise from $178 billion to $360 billion. The biggest drop
was in hedge funds, which saw their assets decrease 10%, from $755 billion to
$675 billion.
“As capital
supply and competition have increased in some segments of the illiquid credit
universe, yields are not always offering sufficient compensation for
illiquidity and risk,” says Brad Morrow, head of manager research, North
America, at Willis Towers Watson. “At the same time, we have seen some
withdrawal of capital from hedge funds in the face of high fees, skewed
alignment of interests and performance headwinds. It appears the growing
groundswell of negative sentiment that has arisen due to the aforementioned
issues is now showing up in the decisions of asset allocators.”
Willis Towers
Watson’s full report on alternative assets can be downloaded here.
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“A single number often cannot
comprehensively address an issue as complex as the obligation or funded
status of a pension plan,” the American Academy of Actuaries notes in an
Issue Brief.
The
academy notes that news reports may indicate that a defined benefit
(DB) retirement plan of a major local employer is underfunded by $50
million, while the employer’s leadership reported in an interview the
previous week that the plan was in solid financial shape and consistent
with its financial plan. Both could be telling the truth.
“The
primary reason why there is more than one right number [for reporting
pension funding] is that different measurements of actuarial obligations
can communicate very different information,” the paper says.
“Settlement” measurements can include measurements designed to show how
much it would cost a plan sponsor to transfer the responsibility of
supporting a plan to an insurance company or other financial
institution; the amount of assets that would be necessary to back the
pension obligations with a dedicated portfolio of low-risk bonds with
cash flows that are aligned with the projected pension benefit payments;
or the price at which pension obligations would trade, should a market
exist on which they could be bought and sold. A “budget” measurement
could represent an estimate of how much money the plan would need to
have in order for a projection to show that the assets are expected to
be sufficient to cover projected benefit payments.
One difference
between a budget measurement and a settlement calculation is that the
budget approach includes an estimate of the future investment returns
that the plan assets will earn, including any expected incremental
return from investing in risky assets. The paper notes that for most
diversified investment portfolios, such an estimate is inherently
uncertain, and assumptions can vary among those making the calculation.
“A settlement valuation relies only on financial information available
in today’s financial markets,” the paper explains.
A plan that is
100% funded on a budget basis is subject to the risk that experience
may be less favorable than anticipated, which could cause the plan to
become underfunded in the future and may jeopardize the security of
participant benefits. Being 100% funded on a settlement basis means that
the actuary has concluded that a plan holds sufficient assets to
transfer the responsibility for supporting the plan’s obligations to a
third party. “This suggests that it is possible, and perhaps likely,
that a lesser amount of assets would be sufficient to pay all benefits
if the plan sponsor were willing and able to take on risk. Therefore,
the sponsor of a plan that is 100% funded on a settlement basis may have
contributed more to the plan than was actually needed to pay all
participant benefits,” the brief says.
NEXT: The purpose of different measurements
Understanding the purpose of the measurement is a prerequisite for
selecting the methodology or multiple methodologies most useful to
satisfying that purpose, the academy points out.
According to the paper, some of the key questions to consider include:
Can the plan sponsor afford the downside risk of increased cost if assumptions are not realized?
Do participants expect there is 100% certainty that their benefits will be paid?
Is it critical that there be no risk of an obligation being unmet?
Is it more important that scarce resources are allocated between competing priorities?
Is determining when resources will be allocated to a particular purpose most important?
For
example, some DB plan sponsors may focus on guaranteed benefit
security, while also taking into consideration expected cash flow needs,
a desire for level expenditures, and the ability to liquidate assets.
In some cases, the continuing viability of the entity sponsoring a
pension plan might be a concern, so ensuring the solvency of the plan to
pay all promised benefits may be paramount. In such a case, the
measurement might use risk-free rates of return and the other
conservative assumptions.
Alternatively, for a sponsor that is
economically healthy with strong growth prospects, creditworthiness
and/or fluctuation in cash contributions to the plan may not be a
significant concern. According to the paper, the measurements needed in
these cases may focus on planning for how much will be contributed to
the plan and for when those contributions will be made. Assumptions that
reflect a higher level of risk may be acceptable within that context.
Another
example the academy gives is a situation in which investors are
considering acquiring an enterprise that sponsors a pension plan. If
they intend to terminate the plan, the measurement of the plan
obligation that is most important is likely to be a settlement
measurement that considers the cost of placing the pension obligation
with a third party. If they will continue sponsoring the plan, then
determining future contributions in a manner that reflects their
anticipated investment strategy may be appropriate.
Important points to note, according to the paper, are:
For many plans, multiple obligation measures must be calculated and used in different ways to assess plan funding levels;
Regulators do not always agree on the best measurement type for a given purpose; and
The type of measurement used for a given calculation can, and often does, change over time.
“Because there is more than one right number, an informed follower of
pension issues would want to become familiar with the measures commonly
used in each area,” the academy concludes.