A guide to impact investing for pensions

Florence Dard and Deborah Shire explore alternatives and impact investing

clock • 5 min read
AXA IM says it has seen increased demand for its natural capital strategy
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AXA IM says it has seen increased demand for its natural capital strategy

The alternatives asset class has grown significantly in prominence, with increasing flows and demand driven by a decade-long bull run, an environment of low interest rates and low inflation, and the resulting search for yield, diversification and enhanced risk mitigation.

Looking at historical allocations of institutional investor assets into alternatives, investments have tripled over the last decade and the industry is expected to continue to grow at a sizeable 9.3% CAGR for the next five years, according to Preqin.

That said, the shifting market environment in 2022 and the return of yield to the public markets saw some institutional investors slow down their investments into alternative asset classes and reconsider the role alternatives play in a portfolio.

This has particularly been the case with private equity and real estate, exacerbated by last year's liability-driven investment (LDI) crisis and resulting liquidity crunch, which drove investors to re-evaluate the value of liquidity in portfolios whilst remaining allocated to low-volatility assets. Today, some alternative asset classes are back in favour where others are suffering from lower relative value as compared to their public counterparts.

Against this backdrop, at AXA IM Alts, we see a few distinct areas of opportunity from both an investment and demand perspective.

Real estate and infrastructure

In today's market, some real estate assets have already repriced, while some have just started to do so. As a result, investors are increasing their focus on valuations to find the right entry point to re-engage with the asset class. Even for long-term investors, finding the right entry point is key: we are beginning to see re-engagement with these asset classes through investing in specialty sectors such as logistics, that has been swift to adjust to this new environment.

Whilst sentiment remains cautious, sectors underpinned by global megatrends such as demographics, urbanisation, digitalisation or decarbonisation still offer long term growth prospects and potential rent increase. For example, centrally located office assets offering premium amenities and strong green and energy cost efficiency credentials, or student housing assets with modern amenities in locations with low student bed provision rates offer appealing investment opportunities.

Some alternative asset classes also offer a natural protection against inflation: this is especially true for infrastructure, which also offers attractive yield and resilience in case of economic slowdown. Though fundraising has been quite tepid in the first half of 2023, the role of infrastructure in the transition to a net zero world through renewables, as well as decarbonised infrastructure, such as district heating or electric transportation, offer strong growth prospects for the asset class where most institutions remain under allocated.

Private debt

Most debt strategies offer natural protection against rising interest rates with returns based on floating rates and wider spreads post repricing, such as significant risk transfer (SRT) and commercial real estate (CRE) debt. Still, after a relatively benign economic environment, the current negative economic prospects reinforce the importance of diligence within credit selections, sector allocations and discipline in underwriting.

Within private debt, we are seeing increased opportunities and value in specific sub-asset classes. We are seeing repriced returns and opportunities across the whole loan structure within CRE debt, which is a direct result of pronounced bank retrenchment combined with large Capex requirements to meet tougher ESG regulations and obsolescence risks. In what has become a "lender market", alternative lenders also benefit from more conversative loans-to-value based on corrected market valuations and more lender-friendly structures with tighter covenants.

While banks retrench from those markets, they are focusing on their core, strong performing, mainly investment grade credit portfolios, and their need for capital has led to increased volumes and widening of spreads for SRT. The SRT asset class seeks to provide tier 1 capital to banks while allowing investors to get access to the best quality and highly diversified loans originated by banks.

The SRT market has been growing rapidly in recent years, having doubled in size since 2016. Issuance has generalised throughout major banks around the world. An increasing number of pension funds are also looking to build more diversified private debt portfolios, combining direct lending with investments in SRT funds having the scale, track record and extensive market access and subsequent ability to negotiate bilateral trades for high quality portfolios and preferential terms and conditions.

In the context of higher rates and higher volatility, pension funds have larger allocations to debt or income-driven strategies in the private markets space that can be diversified across the above ideas.

These strategies typically are mixed with more liquid structured credit investments that benefit from attractive levels of spreads, very strong level of protection against market downturn and proven liquidity, similar to asset-backed securities (ABS), which offer good diversification from corporate risk due to underlying portfolios made up of consumer loans which perform well due to good fundamentals, providing lower volatility as a result of their low duration. ABS solutions also offer a spread pick up comparable to investment grade corporate for an equivalent rating.

Impact investing

Finally, appetite remains strong for impact investing, particularly solutions targeting the E and the S of ESG, as they bring a different value proposition with tangible and measurable impact.

We have experienced increased demand in both the AXA IM Alts' natural capital strategy, which finances activity that protects vulnerable and high-value natural habitats from deforestation quantified through carbon credits, and the AXA IM Alts' global healthcare strategy, which invests in healthcare solutions and products that are affordable enough so that they can be distributed in high volume and middle-income markets. Both strategies, which are addressing largely unmet needs, can have a very concrete positive impact, while delivering performance.

Florence Dard is global head of client group and Deborah Shire is deputy head of AXA IM Alts

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