A 40 minute interactive lesson with Prof. Victoria Ivashina
PFA Pension: Strategy 2020
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.
It contained three main initiatives:
- Find new sources of investment return
- Unlisted investments
- New markets and asset classes
- Extension of strategies
- 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
- 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
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
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.
They can basically run an internal private equity firm - no fee or carry to external managers.
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.
It probably has the capital to buy certain companies outright, without needing to incur cost of capital (other than opportunity cost).
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.
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.
PFA now has to manage its investment, which is... a full-time job for a PE firm.
1) Growing competition 2) Strategic focus/specialization given broad advantage of size 3) Risk mitigation strategies
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.