Corporate DB plans, unlike the corporate investors, capital markets and FX risk managers (see related story) have not been as concerned about the credit market’s turmoil and liquidity squeeze. That’s because pension funds don’t look at the market daily, weekly or even quarterly. “We’re not managing performance for the month,” one manager said: “We measure increments of 1 and 2 years,” said the investment officer of one large DB plan.
Indeed, some DB plans, which have been moving toward a closer match-up of their asset and liabilities profile, have discovered their shift has become a sort of natural hedge. “Most of the ‘blow ups’ have been in the quant/equity world and not in regular fixed income markets,” noted an investment manager for a corporate fund. Over the month of July, “we were actually positive,” he said. August won’t look as good but in the aggregate, the volatility is unlikely to affect his company’s asset performance significantly. “Our large funds were only down 1 percent, and most of it was due to the one fund that has remained primarily equity based.”
What was interesting to this investment chief and others is that niche players in the pension investment market (offering unique strategies) either did very well or totally flunked. “One of our managers ended up 1500 bps below their benchmark,” one reported, “and gained 400 bps the next week.”
LESSONS LEARNED
Assuming the volatility subsides and liquidity returns, corporate sponsors said they planned on getting weekly and monthly updates across their managers’ universe and keeping a watchful eye on their asset base.
But perhaps the most valuable lesson learned through the process is that diversification across assets does not always produce the volatility-reduction impact fund managers plan on: in the case of the recent crisis, previously uncorrelated assets moved in tandem, exacerbating losses. As a result, industry players argue, DB plan sponsors are likely to look into some (even more) uncorrelated assets, such as real estate, commercial REITs and infrastructure finance. “We still have too many of our eggs in the equity basket,” one plan sponsored concurred.
FINDING NEW ASSETS
As investors seek out new opportunities for diversification, “the middle market LBO funds are the real beneficiaries,” according to Adam Frieman, principal at Probitas. While the large deals left many banks saddled with expensive committed loans (Chrysler is the perfect example), the smaller deals, and increasingly ones arranged by funds that specialize in bailing out distressed companies, look more appetizing. “DBs are not reducing their exposure to private equity,” Mr. Frieman said.
Another area where Probitas had noticed some interest was in participating in infrastructure financing deals: in particular in the wake of the bridge collapse in Minneapolis. Mr. Frieman noted that there’s billions of dollars needed to finance large infrastructure projects, and the PE firms, and by default, their pension fund clients, are getting in on the deals.
Mr. Frieman pointed out that infrastructure deals are of interest to DB plans because:
1) The financings have a better risk/return profile vis-a-vis traditional LBO and PE vehicles;
2) The deals typically have fixed-income-like characteristics but at a higher yield vs. regular fixed-income assets, which fit well within DB’s LDI framework.
But market analysts note that like other forms of credit-linked financing, the commercial bank and PE firm community are having a hard time syndicating and selling off their existing commitments—let alone taking on new ones. A recent report in the Financial Times indicated that banks were already saddled with $34bn of “paralyzed” infrastructure financing that they cannot get off their balance sheets.
A similarly cautionary remark was published by S&P in early September: it noted that infrastructure assets, e.g., airports and utilities, had been popular LBO targets in recent years and the buyers are already experiencing difficulties generating the cash flows required to cover their debt costs.
The upshot for corporate pension fund investment managers: while alternative assets are a likely beneficiary in the wake of the credit market turmoil, and fixed-income profiles are in demand, the pain inflicted on banks and PE firms may last longer, thus
1) Choking off their own appetite for financing new deals, be they REITs, infrastructure or otherwise; and
2) Raising a red flag for investors about the extent of exposures banks already have (see related story) as well as the credit analysis “standards” on which they rely in order to assess their managers’ mandates and risk/return expectations.