Ways to pep up your pension returns

“Alternative” investments can be risky, but are worth considering if you want to increase your pension returns.

Savers whose retirement funds are invested only in “conventional” assets could be missing out, according to a new study by pension specialist JLT Employee Benefits. The research suggests that allocating 20% of portfolios to illiquid alternative investments could boost the value at retirement of the typical fund by up to 12%.

Investments in this category include private equity, private debt, infrastructure and real estate. Many occupational pension funds routinely ignore these asset classes, notes JLT, focusing instead on listed equities and bonds. Savers with private pensions also rarely invest in alternative assets.

The argument for investing more in alternatives lies in the diversification benefits they provide – in other words, history suggests they do not move in the same direction as more traditional assets.

So by adding these assets to the mix, pension-fund managers should be able to reduce the total risk of the portfolio while boosting expected returns.

Over time, the impact of such a shift could be very significant. JLT’s models suggest that a pension fund invested 80% in listed equities and 20% in a mix of alternatives would deliver

8% more over 35 years than an equity-only portfolio. If the alternatives portion was entirely invested in private equity, that outperformance would increase to 12%.

Watch your timing

There are some important caveats to this analysis. First, JLT’s research is based on the performance of professionally run illiquid investment funds – alternative assets are often hard to access individually. Also, many savers might want to reduce exposure to illiquid assets (along with riskier listed assets, such as equities) in the run up to retirement, as their time horizon shrinks.

Remember too that this is historic analysis. Pension funds have a tendency to start paying attention to asset classes when they are expensive, rather than cheap, and many would argue that private equity, for example, is in something of a bubble right now. The government – not known for its good market timing – is also keen to encourage increased investment in illiquid assets, partly to boost the capital available to privately owned companies in need of funding. Last month it issued plans that would allow small occupational pension funds to co-invest in alternative assets.

With all this in mind, illiquid assets can be worth a look – our story on timber this week (see page 24) offers one good example of the potential benefits on offer.