Pension fund assets are set to grow at a Compound Annual Growth Rate of 5.4 per cent between 2018 and 2025, according to a new report by the Association of Luxembourg Fund Industry has found.

Assets are expected to increase from USD 42.2trn to USD 61.1trn. The report, published by PwC Luxembourg, also found that pension funds are increasingly looking for investments outside their own countries as well as investing in alternatives, as part of their search for yield. It attributes this to low interest rate environments in many developed countries, alongside a rise in volatile equity markets.

In terms of asset allocation, equity continues to hold the crown, accounting for 38 per cent of total pension assets at the end of 2018. However, growth, in percentage terms, has turned negative – with allocation falling from 60 per cent in 1998. Alternatives are expected to play an increasingly important role in pension funds’ portfolios as they continue to search for yield. In absolute terms, pension fund alternatives AuM has risen from USD 9.2trn in 2014 to USD 11.6trn at the end of 2018.

PwC Luxembourg head of asset and wealth management, Oliver Weber, said: “In light of the current global investment environment, pension funds, with their ability to weather periods of market instability, are also upping their allocations to alternatives, including notably illiquid assets such as private equity and infrastructure. In search for diversification, pension funds are not only looking in terms of asset class, but also geography. They are going beyond their borders in search for growth – either through direct investments or, increasingly, using funds such as AIFs or UCITS.”

Globally, regulations governing pension fund foreign exposure continue to differ drastically. While the majority of countries examined do not set any limits regarding foreign investments, some have set limits for non-OECD or non-EEA countries. Additionally, others have set limits for specific asset classes. Overall, however, there has been an increase in pension funds’ foreign exposure since 2014, rising from 31-34 per cent at the end of 2018.

Commenting, Alfi chairperson, Corinne Lamesch, said: “Pension fund regulations still differ from one country to the other. In particular some countries restrict the amount pension funds can allocate to investment funds or foreign investments. Consequently, navigating the terrain of complex local requirements can be challenging for asset managers.”

The average foreign investment of pension funds for considered countries stands at 34 per cent of their assets, however regionally the differences are stark. Europe has one of the most developed markets, with pension funds from the region allocating 35 per cent of their assets to foreign markets.

In addition, pension funds are looking to align their investments with Sustainable Development Goals (SDGs) and Environmental, Social & Governance (ESG) factors, with EU pension funds leading the pack.

Member states across the union have developed (or are in the process of developing) initiatives to encourage ESG integration by pension funds. In the UK, the Department of Work and Pensions issued a new regulation requiring pension funds to consider ESG and ethical elements during investment decisions. In France, the 2015 law on energy transition for green growth, created mandatory ESG and climate policy reporting for all asset owners.

Lamesch concluded: “Another key development since the 2015 edition of the report is the growing focus on sustainability of the investments made by pension funds. Luxembourg has been a pioneer in this field and is today the leading domicile for sustainable funds in Europe. Further, UCITS remains a key vehicle for many pension funds seeking exposure to worldwide markets. We expect this trend to continue given the sound regulatory framework, the high level of investor protection and the depth of global capability embedded in the structure.”

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