A 40 minute interactive lesson with Prof. Victoria Ivashina

PFA Pension: Strategy 2020

Section 1 of 12

For larger investors, co-investing alongside a traditional fund structure and direct investing (i.e., skipping the fund structure entirely) have become ubiquitous in the alternative investment space.

Two main factors are behind the trend: (1) It is an expensive asset class, and high net returns are not guaranteed, and (2) a global low interest rate environment appears unlikely to reset in the foreseeable future. The aftermath of the 2008 global financial crisis that brought near zero, if not negative, interest rates for many economies has pushed many investors to move aggressively into the alternative asset classes. At the same time, many of them were asking “Why can’t I just do this myself? Do I really need a fund, or a fund of funds to access this asset class?” This movement has put a lot of pressure on the industry and has changed many of the ways in which they operate. Next, we’ll examine these changes and their implications.
Section 2 of 12
Section 3 of 12
Section 3 of 12

PFA’s decision to expand into alternative investments was based on the following views:

  • Low global interest rate environment
  • Shrinking public market and increasing opportunities in the private space
  • PFA’s competitive advantage as one of the largest pools of capital in Europe

PFA’s clients made their decisions about which fund to invest with based on a five-part balanced scorecard:

  • Net returns
  • Administrative cost
  • Cost of insurance benefits connected to pension plans
  • Total cost, including traditional costs such as rent and administration, and all costs associated with investment management
  • Service level

For corporate clients, a consultant would review the above criteria every three to five years and make investment recommendations. At this time, if PFA remained the preferred fund, their corporate clients (the companies investing their pensions with PFA) would renew their contracts. If not, they would leave for a different fund.

How PFA expanded into the alternative space had to account not only for the net returns but also for the cost of investing in this space, which is why PFA decided to lever its scale to come out with a customized strategy of alternative investing.

PFA is a private pension fund, which means that it manages the money on behalf of current and future retirees. (Although we will not dive into the implications of the type of funds for investment management, PFA is primarily a defined contribution (DC) pension plan.) The liabilities of these clients (the pensions) are often decades into the future.

Section 4 of 12

Does this mean that PFA’s horizon for tackling these challenges is also long term?

  • Is PFA’s horizon for tackling these challenges long term?
    Please select yes or no.
Section 5 of 12

To meet their investment needs, they created a program called Strategy 2020.

It contained three main initiatives:

  1. Find new sources of investment return
    • Unlisted investments
    • New markets and asset classes
    • Extension of strategies
  2. Expand investment areas
    • Focusing on exploiting economies of scale
    • Upscaling "in-house asset management" and adding new investment skills (alternatives)
    • Having stronger risk management and developing/improving systems
  3. Focus on risk-adjusted return
    • Focus on absolute real return
    • Move away from the benchmark mindset
    • Maximize long-term return in a cost-effective and responsible manner
Section 6 of 12
Section 7 of 12
Section 7 of 12
As a way of achieving their strategic investment goals, PFA intends to become a co-investor and direct investor in the alternative space.
Section 8 of 12
Section 9 of 12

Regionally, PFA is a very large, highly capitalized pension fund. What edge do you think this might give it?

Peer responses

" "

1) Economies of scale 2) Access to capital and ability to hold illiquid assets 3) Ability to employ leverage 4) Specialization in certain markets/industry segments

E, Abu Dhabi

" "

PFA can achieve economies of scale through pooling investments and increased skills in alternative investments. It can take advantage of ad hoc inefficiencies in the markets.

M, France

" "

They can basically run an internal private equity firm - no fee or carry to external managers.

J, United States

" "

1) The talent pool and the expertise in the research in certain industry. 2)The cost of funding is cheaper, as its directly from the contributions from DC plan, and they usually have very good relationship with banks. 3) Their long-term investment horizon and diverse portfolio in other asset classes. 4) Their good reputation. The private company would love to have PFA to be their investors as this will give confidence to the rest of the market.

Y, Canada

" "

It probably has the capital to buy certain companies outright, without needing to incur cost of capital (other than opportunity cost).

S, United States

Section 10 of 12
Section 11 of 12

So that’s what PFA can bring to the table. Now let’s consider the other side. What are the potential challenges of PFA’s new initiative to invest in alternative investments?

Peer responses

" "

PFA has a ton of flexibility with capital and mainly looks to co-invest together with the owner/family business for many years. Challenges can arise if the owner/family business doesnt see eye-to-eye with PFA - especially if PFA has a minority stake, which often do.

J, United States

" "

1) It might also be hard for PFA to invest in early stage companies (VC targets) due to their long term commitment to the future retirees. 2) PE firms have extensive deal sourcing systems and network, it also seems challenging for PFA to build that in short term. It could also be challenging to hire the managers with that domain expertise. 3) PFAs corporate client is looking to renew contract in 3-5years, its also possible that the private investments only start to generate return after 3-5years. So the timing is also challenging.

Y, Canada

" "

PFA now has to manage its investment, which is... a full-time job for a PE firm.

S, United States

" "

1) Growing competition 2) Strategic focus/specialization given broad advantage of size 3) Risk mitigation strategies

E, Abu Dhabi

" "

PFA must bring the network and non-financial added value during its co-investments. In addition, alternative investments require the long term to create value.

M, France

Section 12 of 12