The Role Of Alternative Assets In Pension Portfolios, Examined Through Risk Factor Analysis
In recent years, alternative assets such as agricultural land, real estate, and infrastructure have become staple investments in the portfolios of investors both large and small. This is for good cause. Alternatives provide new and compelling sources of yield and potential for capital gains that have low correlation to traditional capital markets. This relationship to traditional capital markets is the key to the valuable diversification benefits that alternatives can bring to a pension portfolio. In this article, we explore the drivers of this diversification through a risk factor framework.
Alternative investments have grown both in number and size since the 1990s and have also become widely recognized as one of the sources of outperformance of major Canadian pension plans. The ‘Pension Investment Association of Canada (PIAC) Annual Asset Allocation Survey’ shows that defined benefit plans have steadily increased their participation in alternatives over the past 20 years. And, Preqin’s tracking of public pension funds confirms the same concept, with median allocations to alternatives in the funds covered rising from 18.1 per cent in 2010 to 30.3 per cent in 2020 (See Chart 1).
Pension investors may seek alternative investments for reliable income streams, inflation hedging, risk management, low correlation to other asset classes, higher risk-adjusted returns, and, importantly, diversification.
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