For a Decade, Pensions Wanted Yield From Real Assets. Now They Want Inflation Protection.

Real assets are being asked to do double duty: provide yield when rates are low and hedge against inflation.

Illustration by II

Illustration by II

In the endless quest for yield, state pensions have been quietly moving a significant amount of money into real assets over the last decade. Now they are hoping these investments can protect them from inflation.

Between 2011 and 2021, institutional investors increased their aggregate allocations to real assets — including commodities, precious metals, real estate, and natural resources — by 7.8 percent, according to a new report from Wilshire Associates on state retirement systems. Total public pension plan allocations to U.S. and non U.S. equity and fixed income decreased by 2.5 percent during the same period.

State pensions cut fixed income as rates fell. “Most investors are aware that yields across fixed income have been falling pretty much for the past 10 years,” Ned McGuire, managing director at Wilshire, told Institutional Investor.

Not surprisingly, McGuire said, public investors have been on the hunt for assets with higher expected returns and have primarily turned to higher yielding real assets. According to Wilshire’s December 2021 capital market assumptions, real assets provided a 5.9 percent expected return, while fixed income’s was only 2 percent.

Real assets often have a low correlation to the performance of stocks and bonds, which makes them a potentially ideal holding during periods of market volatility and underperformance. Real assets are also generally positively correlated with inflation, which, while relatively tame over the past decade, has spiraled upward over the last two years, increasing investors’ desire for protection. “With yesterday’s inflation at over 8 percent again, inflation protection and finding assets that are positively correlated with inflation is now very attractive in the eyes of investors,” McGuire said.

McGuire said that the decrease in equities over the past decade has been concentrated primarily in non-U.S. stocks, with a 3.1 percent decrease from 2011 to 2021. “Over the last 10 years, U.S. equity has significantly outperformed non-U.S., so a lot of investors have gravitated toward U.S. equity [to achieve] higher expected returns,” he said.

Still, state pension plans cut 0.4 percent from their stock allocations. Private equity, in line with gains in all alternative investments, gained 1 percent.

Overall, U.S. stocks still dominate pension plan portfolios, representing 30.8 percent of the total allocation to equity, according to data from the end of fiscal year 2021. Total fixed income represented 22.6 percent, followed by non-U.S. equity at 16.8 percent. Real assets were 14.2 percent of total portfolios, trailed by private equity at 9.6 percent.