Why investing pension funds requires players to think outside the box
It’s a tough time to be investing a pension fund’s cash. Analysis of pension schemes by Actuarial Service East Africa (ActServ) shows overall flat returns over the first quarter this year (0.8 percent) and 2022 (-0.6 percent).
Both returns further trail those posted in the first quarter of 2021 and 2019 at 2.26 percent and 6.5 percent respectively.
In addition, for the year 2022, weighted average returns stood at 1.7 percent – while inflation in the period averaged 7.64 percent.
Amid this pressure, there’s a need to be creative. With treasuries yielding higher, there’s a strong urge to allocate here – 77 percent of pension funds were in fixed income in Q1 2023, up from 76.5 percent in Q1 2022.
But for long-term reasons, they may need to search for credible high-yielding alternatives. Should they turn to alternatives for help? I think so.
Here’s why: I refer to a recent study commissioned by the American Investment Council on Private equity (P.E) returns by public pension funds.
The research, which tracked their performance in the period between 2012 and 2021, found that their private equity allocations delivered greater net fee returns than returns from publicly traded stocks.
In addition, it showed about 85 percent of the public pensions had some exposure to private equity with an average allocation of 8.5 percent.
In summary, the study demonstrated that long-term commitments in this asset class enabled pension schemes to deliver on their mission to provide retirement security for their pensioners.
Why this asset class? One, it’s one of the alternative asset classes available to pension funds. Since 2016, the retirement benefits authority (RBA) has allowed its pension schemes to invest up to 10 percent of their assets under management in this class.
However, investment to date totals less than one percent compared unfavourably to Uganda which has a 2.2 percent commitment from its pension funds. Nonetheless, the journey has begun.
Two; Kenya is a hub for many private equity operations within the region and already attracts huge allocations from foreign private equity capital compared to the region.
Three, with private markets increasing their role in capital formation, it is important that pension funds have access to these investments.
They not only help diversify their portfolios but help provide critical capital to small and medium-sized enterprises and support jobs, all the while generating impressive long-term returns.
Now, considering most pension schemes have asset values of less than Sh1 billion, an allocation of 10 percent to private equity or Sh100 million would not meet the minimum investment threshold for most private equity funds.
In that case, a fund of funds (FoF) model is ideal where capital is aggregated from smaller schemes and into a single pool. Commitments are thereafter made to a number of private equity partnerships.
Research by FSD Africa supports the above model as FoFs boast long-standing relationships with many private equity managers and have good knowledge of the investment landscape.
This is useful as it would address the expressed reservations of Kenyan pension scheme trustees on the lack of directly available benchmarking and performance data.
Ultimately, in order to offer retirement security for our essential workforce, local pension funds need to broaden their asset class options. Private equity is one of these options.
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