Alternative investments grow in attractiveness

Alternative investments have become a valuable income stream and liability matching tool at UK pension fund Centrica says Chetan Ghosh, Chief investment Officer at the £6.7 billion pension fund. With current gilt yields making liability matching expensive, the fund has begun investing in alternative strategies that include solar panel installations benefiting from the government’s Feed-in-Tariff, new builds benefiting from ground rental income and social housing, explains Ghosh, speaking at the Fiduciary Investors Symposium at Oxford University’s Rhodes House.

“We are quite a young pension scheme, spun out of British Gas in 1997. It means we have no legacy of pensioners from the 1950s and 1960s and this allows us a long-term horizon. However the tensions we are trying to solve involve taking risk off the table, with a long-term ambition to meet our liabilities and the pension promises we made, but also wanting to invest to grow our asset base,” he says. The fund currently has around 7.5 per cent of assets in long-dated cash flow generating mandates, avoiding the need to buy gilts at very low yields.

Centrica eschews any fixed or static allocation to alternatives warning that an assets attractiveness – like rental income – can “change quickly” requiring a fleet-of-foot. Centrica funded its alternative purchases by selling some of its Gilt portfolio, but synthetically retaining a gilts exposure.

Its alternative allocation is characterised as long-dated and illiquid, inflation linked – although the fund is starting to look at assets that aren’t inflation linked – and with high levels of cash flow. Offering advice to other investors, Ghosh counsels patience as deploying money to alternative investments can take time, and the importance of having a manager “you can trust.” Scarcity of supply is another bugbear although he says “time is on our side to build up our allocation; we will be fussy.” Centrica’s alternatives program has also “thrown off a lot of cash flow” requiring a “continuous program of investment.”

Tomas Franzen, Chief Investment Strategist, at the Second Swedish National Pension Fund AP2 has sought out alternative investments in line with the fund’s risk management strategy to diversify.

“Our core business is compensation for taking on risk. But as we take on risk we also need to manage that, and the most important risk management tool is diversification,” he explains.

Although Franzen “isn’t trying to replicate hedge fund strategies” in his alternative portfolio, investment ideas have come from research of the hedge fund space and he admits it is a “cheaper way than investing in hedge funds.” Strategies include benefiting from currency carry or unexpectedly sharp currency depreciation, merger arbitrage, shorting volatility and insurance linked securities, he says.