If you're fed up with the stock market's unpredictability or have been unhappy with how your investments have performed, consider applying a pension fund-style investment strategy.
Of the 300 largest pensions in the world, Canada is home to four of the top 20 performing funds. Pension funds are among the most careful of investors because they're stewards of money that current and future retirees are counting on for retirement income. Their goal: pursue investment strategies that earn strong returns, minimize volatility and keep up with inflation.
Managers of pension fund investment portfolios are increasingly considering alternative, non-correlated investments and diversifying away from a Canadian market that is dominated by just three sectors (financials, energy and materials) and investing directly in hard asset real estate and infrastructure.
Their mission isn't that different from the individual investor. So here are some ideas on how to invest like a pension fund.
Global markets
For the past several years, Canadian pension funds have been moving a significant amount of money out of Canadian stocks and into global markets, because over 75% of our stock market is concentrated in only three sectors, creating a very volatile marketplace.
Additionally, the result of good global diversification is exposure to the economies of various countries and their currencies, reducing overall volatility and offering the potential for better returns.
As an individual investor, global markets should have a place in your portfolio.
Broad asset mix
The average pension fund holds about 20% of its assets in publicly traded bonds and 30% in publicly traded stocks. The remaining allocation is made up of commercial real estate, mortgages, private equity, private debt and other alternative strategies. This mix is a far cry from the conventional 60/40 stocks and bonds allocation that has long dominated many investors' portfolios.
Alternative investments
Pensions are replacing traditional equities with "alternative investments" across North America, such as shopping malls, office buildings, infrastructure, private equity, private debt, mortgages and other assets.
They are also taking a Warren Buffett-like approach of focusing on high-quality companies and not overpaying for them. For example, in 2009 Canada Pension Plan's investment board invested $300 million for a 15% stake in Skype, which turned into almost $1 billion over a two-year period after Microsoft bought the company.
The BC Investment Management Corp. has almost 20% of its assets directly invested in hard asset real estate. Pensions like infrastructure and real estate for several reasons; one of them is that they offer consistent and stable returns of about 7% to 8%, sometimes more.
The easiest way for an individual investor to buy into high-quality real estate is to buy into a fund or REIT that holds these assets; however, this isn't necessarily ideal because REITs are still subject to market movement.
Better yet, an accredited investor might want to consider a well-managed and proven real estate limited partnership (RELP) where investors pool their cash either directly, or through a manager or management team, to buy and manage one or more real estate assets. Investors receive regular distributions through the operation, lease or sale of said properties, minus a management fee.
These are preferable, because they have less correlation to the markets than a REIT. Not all RELPs are created equal, though, so it's important to do your homework to find the right one.
The main goal of buying into a RELP is the promise of higher returns and less volatility than a REIT.
Heavy weighting in bonds
The Canadian Pension Plan, a $153 billion portfolio, invests approximately 30% in bonds, which includes Canadian government and corporate bonds, foreign government bonds and non-marketable bonds. How you can do it yourself: bond ETFs or mutual funds or individual bonds and GICs.
Individual investors can't pursue all investment moves made by pension funds, but if you work with a wealth manager, see if he or she has access to institutional-grade investments similar to what pension funds invest in, which is usually not available to the retail investor.
If you don't work with a wealth manager, there are still some broad concepts in portfolio design that you can consider to build your wealth. Pick an extensively diversified asset mix, look to global markets and emphasize investments that provide consistent returns such as dividends.
That's how some of the most successful pension funds and asset management firms in the country are handling today's volatile markets. •
