I recently moved house and for my morning commute to the train station, I continued to use the route I was familiar with. It was not until recently that someone told me about an alternative route to the station. Yes, it was a B road and slightly more complex to navigate but it was a much more pleasant drive, involved less traffic and, more importantly, was a quicker commute to the station. There was nothing wrong with my original route but my comfort and familiarity with it meant that I had not considered an alternative… until it was pointed out to me.

What does that have to do with pension scheme investments, you may ask? Well, most pension schemes have identified their longterm objective, whether that is buyout or self-sufficiency, and a direction of travel to reach that objective.

However, many schemes’ investment strategies continue to focus on the use of traditional asset classes, or those which are familiar, in order to achieve those objectives. Whilst the performance from traditional assets has been strong over the past few years, the outlook is less compelling.

In our opinion, there are currently attractive alternative investment opportunities which pension schemes should be considering as part of their overall strategy. These opportunities can improve the likelihood of schemes meeting their long-term objective, diversify their portfolio, and reduce their reliance on traditional assets.

Two strategies we think are appealing from a strategic perspective are infrastructure equity and private credit.

Infrastructure refers to largescale systems; services and facilities that are necessary for economic activity. The assets are associated with the provision of public goods and essential services. They tend to have monopolistic characteristics and high barriers to entry, which should mean their performance is less impacted by economic conditions (although there is no guarantee of this). Examples include airports, renewables, telecommunication networks and utilities.

For pension schemes, infrastructure equity has a number of characteristics which we believe makes a compelling case for its inclusion within portfolios. Whilst past performance is not a guide to the future, these characteristics included steady cash flow generation, low correlation to other traditional asset classes, and an attractive risk-return profile. We believe that the return expectation for infrastructure is around 7% per annum over 10 years which, we feel, is favourable on a risk-adjusted basis compared to a range of fixed income, equity and other alternative strategies. Private credit is another area that offers a unique and compelling investment opportunity to pension schemes due to its attractive risk-return characteristics and the income it provides.

This opportunity has arisen following the new bank regulations implemented in response to the last global financial crisis.

Many companies relied on banks for borrowing but, as banks have reduced lending, institutional investors like pension schemes have the opportunity to capture enhanced returns by providing finance in private markets.

There is a wide range of strategies within this area, from loans which are secured, backed by, say, an underlying property, or that rank high in the company’s capital structure and therefore benefit from better recovery rates than traditional bond investments, to higher risk strategies which target a higher level of return. Funds specialising in this asset class tend to target net-of-fee returns ranging from 3% for lower risk senior loans, to the low teens for higher-yielding loan strategies.

We believe the attractiveness of private credit strategies relative to other traditional assets include high potential returns, income generation to meet cash flows and, increased diversification.

Infrastructure and private credit strategies are not without their risks, and schemes should be aware of these before investing.

For example, both of these strategies are less liquid than traditional public market assets. In addition, manager selection is essential.

Pension schemes have been on an interesting journey over the past decade. Whilst they continue to navigate the numerous challenges ahead in order to reach their destination, we would encourage schemes to consider the alternative approaches available which may help reach that destination sooner. There are many roads one can take but, as the poet Robert Frost said, ‘Two roads diverged in a wood and I – I took the one less travelled by, and that has made all the difference’.

By Jeffrey Mulluck – Aon

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