Spurred by low yields and rising liabilities, Asia’s pension funds aim to significantly increase investment risk and insourcing, but have unrealistic expectations of their ability to do so, found a State Street survey*.

Talent would likely be hard to come by, and funds should not underestimate the extent to which they need to buildout their internal capabilities, said Kevin Wong, head of sector solutions for Asia Pacific at State Street.

While 78% of respondents globally expected to boost investment risk over the next three years, a larger proportion (88%) of those in Asia Pacific planned to do the same (see figure 1).

Figure 1

Four out of five Asia-Pacific pensions aim to run more assets in-house, and they also intend to demand more of their asset managers.

That may sound like bad news for external managers, but pension funds will continue to outsource in key areas, such as alternatives investments, and forge deeper relationships with managers.

Insourcing will likely be more related to domestic equities and bonds, with which funds are more familiar, said Wong.

The report forecast that a hybrid model would emerge, whereby pension funds build stronger partnerships with external managers that can service increasingly complex portfolios for lower fees with deeper interaction.

But more insourcing requires increased headcount, which would see greater competition for talent, pitting pension funds against asset managers, noted Wong. “The global pool of talent is quite meaningful, but in Apac there are more challenges. Pension funds will fight tooth-and-nail with the broader asset manager and alternatives industry."

Moving up the risk curve, pension funds in Asia were keenest on direct loans, the survey found, with almost two-thirds intending to increase existing allocations. Second favourite was real estate, followed by single-manager hedge funds (see figure 2).

Figure 2

That differed from the global response, which favoured private equity above all, followed by direct loans and real estate.

Wong said the prominence of direct loans was surprising. One reason for it might be that as banks rein in their lending in Asia on the back of Basel 3 capital-adequacy rules, pension funds are being seen as an alternative source of financing, he suggested.

Just over half of pensions in Asia Pacific intend to deploy lower-cost investment strategies, and a fifth will seek to reduce the number of external consultants they use.

The challenges funds have encountered with their managers are gaining a complete picture of risk-adjusted return, cited by 64% of respondents; ensuring interests are aligned (63%); conducting due diligence after (44%) and during (44%) the hiring of new managers; and justifying fees (26%).

Figure 3

While managing assets internally is seen as efficient and cost-effective – Finnish pension insurance scheme Ilmarinen reported a 12-basis-point difference between the costs of external and internal investment management – Mark Fawcett, CIO of the UK's National Employment Savings Trust, said: “You need to put systems in place to minimise the risk of error.”

But do pension funds have the operational capabilities and platforms to support internal management?

When it came to strengthening operations, the highest priority was data management, with regulatory compliance coming second, overall governance third, cyber-security fourth, and contingency planning last.

Wong expressed surprise that contingency planning had come low down, and that data management had trumped governance.

"That may be something we need to discuss with funds. Contingency planning could be for something as simple as a system outage, or it could be a global financial crisis," he said.

* The survey was conducted by the Economist Intelligence Unit in August and polled 134 pension fund executives. Just over half came from public-sector funds, about a third from private-sector funds, and 16% from superannuation funds. Twenty-two percent of respondents were from Asia Pacific, 42% from the Americas and 36% from Europe, the Middle East and Africa.