Investing in alternative assets has become increasingly popular among pension funds in recent years. According to a Financial Times report, among the more preferred alternative assets these pension funds target are mortgages. In turn, this has positioned institutional investors to look to the same assets that were previously invested in by banks.
Pension funds are investing billions of dollars into illiquid credit assets such as real estate loans and mortgages to infrastructure debt and non-performing loans. This represents a paradigm shift among pension funds because the amount invested in 2010 was near zero. However, asset managers working with pension funds are preaching to invest in the mortgage sector after the housing crisis in 2008 because of one factor: the global banking industry was substantially de-leveraged, which made the heavy regulations in the sector even more stringent. As a result, this has made opportunities that have attracted institutions like pension funds to the alternative asset classes because these organizations continue to seek higher ROI.
“Investing in alternative assets is popular among pension funds.”
Buy-side firms are pushing pensions to invest in the mortgage market
These buy- side asset management firms traditionally allocate the majority of their investments to liquid capital markets such as fixed-income instruments and equities. According to a recent report by Towers Watson cited by Financial Times, approximately 1 percent of the total investments of its pension fund clients is allocated to illiquid credit assets. However, the firms expects this amount to increase substantially in the near future – up from 5 percent to 10 percent. This growth in popularity of buy-side asset management firms into alternative credit markets is especially significant in the mortgage markets. In fact, special funds serving institutional investors in the Netherlands are now delving into mortgage origination, which means they have entered into direct competition with banking institutions as they chase higher returns for their clients.
Asset managers are now convincing pensions to compete in the mortgage market
One possible solution is for asset managers to work with mortgage originators to provide stronger ROI on loans. This includes non-bank lending institutions that are becoming more prominent in the securitization funding markets. In an interview with the Financial Times, Christopher Redmond, global head of credit at Towers Watson, stated that many asset managers are looking to invest in commercial real estate in nontraditional regions, including Rotterdam, Netherlands, Manchester, U.K. and many other second-tier cities throughout Europe.
“Teaming up with an organization that already originates mortgages and working with them, whether they originate purely for their own balance sheet or others, would not be unusual,” Redmond explained. “Mortgage origination is an opportunity.”
There are questions over whether firms can handle high amounts of illiquid assets. In the same interview, Redmond argued that this is due to the fact that investors do not want to run the risk of forced sales because they have no liquidity in a specific allocation of its asset portfolios.
“You forgo the risk of investing in a high yield mutual fund and 25 per cent of people want their money back and the whole thing has to wind up,” Redmond commented.