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Pension funds should invest up to 20% in infrastructure – report

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EUROPE - Adding infrastructure to a multi-asset portfolio can reduce overall portfolio risks by 35% with the same return, according to a research paper published by German property company IVG.

In the IVG model, when equities delivered negative returns, the optimal infrastructure allocation increased to 47% - a move that reduced overall portfolio risks by as much as 20%, with no impact on returns.

The implication is that infrastructure could provide better diversification than real estate in periods of volatility, despite lower returns.

"Simultaneous inclusion of both assets in particular result in an attractive risk/return profile, including in times of macroeconomic uncertainty," the report said.

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Researchers at the property company found no positive correlation between infrastructure and any other asset class, though it did acknowledge a "certain correspondence" with money market securities.

"This result demonstrates that, particularly for investors wishing to protect the portfolio from losses in value during phases of macroeconomic uncertainty, infrastructure represents an attractive investment option should be added to the portfolio," the report said.

Despite its low risk of loss and expected loss as measured by the value-at-risk ratio, infrastructure is unlikely to contribute significantly to overall portfolio performance, generating an average annual return of 4.15%, according to IVG.

However, returns on infrastructure increased in comparison with other asset classes the longer the investment was held as a result of decreased transaction costs and low probability of loss.

Although there is "no definitive" optimal allocation - because it would depend on variables including the definition of risk, the required return and the investment horizon - IVG said pension funds should boost their allocations to infrastructure to as much as 20% from their current average allocation of 4%.

"In the majority of cases," the paper said, "the theoretical allocation is significantly higher than the level currently seen in most institutional portfolios."

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