Private markets can help pension investors with long-term liabilities expand cashflow-driven strategies, with bonds used to fund early capital calls, according to DWS.
Bond coupons and maturities can finance drawdowns from alternative investments, which typically generate negative cash flow at the outset, said Rene Penzler, co-head of investment solutions at DWS Investment, speaking at the Handelsblatt occupational pension event last week.
He argued that alternatives offer long-term investors, including occupational pension funds, a way to diversify portfolios that remain concentrated in a limited number of issuers, while providing higher return potential than bonds.
“Especially private debt, which has grown at a rate of 10-15% per year in the last few years, will become a large part of the capital market, and the public market will become smaller,” Penzler said.
He noted that direct lending, leveraged loans and high yield “are not suitable for such portfolios”, whereas infrastructure and real estate debt “bring with them a high level of security”, broadening the credit universe. However, investors are currently not better rewarded for taking credit risk in private markets than in public markets, he added.
German corporate pension funds have been increasing bond allocations to manage funding ratios and curb balance sheet volatility amid shifting interest rates. Strong equity performance and higher rates have pushed funding levels to record highs.
Hedging costs, return targets and equity valuations are increasingly influenced by trade tensions and volatile rates, while long-term liability management is becoming more complex, said Martina Régnier, team lead pension solutions at DWS International.
High valuations and market concentration in the US are prompting questions about further allocations. Although the US equity market has held up this year despite economic uncertainty, other indices – including the DAX, as well as benchmarks in Asia, Japan and China – have outperformed.
High valuations typically imply weaker long-term returns, Régnier said, and investors should expect setbacks if they buy at elevated levels. For pension schemes, richer valuations are a “warning signal” but not a reason to exit the US market, she added.
DWS does not expect US equities to repeat the returns of the past decade. The market is, however, positioned to deliver around 6% a year over the next 10 years, while European equities are “somewhat stronger” at around 6.2%, according to Régnier’s presentation.
Across fixed income – including high yield, government bonds and corporates – DWS expects annual returns of 2.7-5.7% over the decade.
“All of this speaks in favour of a solid multi-asset allocation,” Régnier said.
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