Asset owners herding into PE, warns State Street

Asset owners are herding into alternative assets without fully understanding the risks associated with such investments, says Suzanne Duncan, global head at State Street's Center for Applied Research in Boston.

From sovereign wealth funds to family offices, the biggest challenge that institutional investors currently face is the complexity of investing in alternatives, particularly illiquid strategies such as private equity, real estate and infrastructure, she notes.

This worry is compounded by a significant lack of experienced people needed to understand the potential risks of such investments, says Duncan, co-author of a report from the independent think tank she runs that resides within State Street.

Such inexperience has not stopped investors from allocating further resources to the asset class, however. Duncan points to figures from a study by the International Monetary Fund, which found in its 2011 and 2012 global financial stability reports that global pension fund asset allocation to alternatives increased to 16% in 2010, from 11% in 2006.

This trend is also true for Asian sovereign wealth funds, which are looking to increase their exposure to private equity. As reported by AsianInvestor, the Government Investment Corporation of Singapore, Kuwait Investment Authority and reportedly Hong Kong Monetary Authority are investors in a failed fund run by CVC Capital.

AsianInvestor research from our October magazine, polling the top 300 institutional investors in Asia Pacific, also finds a significant shift toward investments into infrastructure, real estate and private equity.

For example, about 30% of the AI300 say they expect to increase their allocation to alternatives in the next 12 months. (See our October edition for the entire survey results – and our November editorial for AsianInvestor’s view on institutional herding.)

Duncan says big sovereign wealth funds are not necessarily prepared for alternatives, despite having recently hired plenty of skilled people.

“You can take the smartest and the brightest skills, but [alternatives] are complex and this is unchartered territory for many of them. They are getting into new types of asset classes that they don’t have experience with, and their boards don’t have experience with,” she argues.

“They need to make sure they know the goal they are striving for. Because we found that many of them are looking at what their peers are doing [and copying them]: herd behaviour.”