Ideas & Debate

Pension funds should bring private equity on board

CASH

Funds now have the leeway to invest broadly for higher returns. FILE PHOTO | NMG

The Biblical journey from Egypt to Canaan – “the Promised Land” – by the Israelites is quite a riveting account. From the parting of the Red Sea, to the issue of Ten Commandments, to the Walls of Jericho falling and much roller-coasting in between, there’s no question this was one epic trip. But the phrase “the land flowing with milk and honey” intrigues me.

Although used hyperbolically to reference the Promised Land’s richness, it represents to me a contrast to the land they were coming from. The land of servitude vis a vis one of freedom. The land of marginal gains vis a vis the land of maximum profit. The land of stagnation vis a vis the land of growth. And in a weird way, I see the local pension fund industry at the start of a similar journey.

Shall it keep 100 percent of low returning traditional investments or incorporate high returning (albeit high risk) alternative investments? The latter is a journey worth taking.

Fast backward in 2016. The industry received the keys to the kingdom. Through changes brought via the Retirement Benefits Act 2016, pension fund managers and trustees got the licence to invest up to 10 percent of assets under their watch in private equity (PE) and venture capital (VC) funds.

However, by the close of 2018, investments in PE represented less than one percent of the nearly Sh1.1 trillion pension industry assets according to the Retirement Benefits Industry Report (June 2018).

Here are three reasons why pension funds should keep pushing forward in this journey. One, diversification: Currently, 36 percent of pension scheme funds are invested in government securities.

Equities (20.7 percent), properties (20 percent) and guaranteed funds (14 percent) follow in that order. Adding alternatives ensures a way of managing risk.

Besides, a small allocation to alternatives is not able or sufficient to generate the required returns. This is the reason why trustees need to give PE investments a more predominant place. And this is not radical.

According to Willis Towers Watson’s Thinking Ahead Institute World 300 2017, the world’s 300 largest pension funds had an average allocation of 21 percent allocation to alternative assets and cash. For countries, North America leads at 34.8 percent. Asia-Pacific (seven percent) and Europe & others (13.7 percent) follow in that order.

Two, matching long-term investment. The nature of pension fund investing is long-term. Matching that long investment horizon with an asset class that is not accessible to short-term investors is crucial to success.

Here’s a great challenge; if the industry has managed to commit close to 20 percent of its assets to real state – an asset that’s both illiquid and long-term and at a level higher than International Standards of 4.5 percent – the switch to PE should be planned to follow the same path.

Three, strategic asset growth. With many deserving small and medium enterprise (SME) shunned by traditional sources of funding, pension funds can become an important funding source. This is also because they increase the amount of market-based funding available to the economy. In the end, the potential for pension contribution is even greater in the SME sector.

The future looks bright. My only wish is that they get there in three weeks rather than the 40 years Israelites took to get to the Promised Land.