five trends reshaping the global pension fund industry

ASSET OWNERS

ASSET OWNERS ASSET OWNERS

Five Trends Reshaping the

Global Pension Fund Industry

2

ASSET OWNERS

Executive Summary

• This executive briefing explores how pension funds are adapting to the challenges of a new

investment environment

• The research presented in this report is based on an international State Street survey, conducted by

the Economist Intelligence Unit in August 2014, of 134 senior executives in the pension fund industry

Five Trends Are

Reshaping the Industry

• RISK

3 out of 4 pension will ramp up their risk appetite as the search for

returns intensifies in a tough investment climate

• INVESTMENT

Private equity will be biggest winner from a surge in alternatives

investment by pension funds

• INSOURCING

Insourcing changes the game as 4 out of 5 pension funds plan to take

control of their destiny and manage more of their assets in-house

• PERFORMANCE

Pension funds set a new threshold for performance from their

asset managers

• GOVERNANCE

Half of pension funds will prioritize improvements to governance as

regulatory scrutiny intensifies

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ASSET OWNERS

In what region are you located?

Americas 42%

APAC 22%

EMEA 36%

3%

20%

77%

We are a regional institution,operating in more than one

country across a single region

We are a global institution,operating in more than one

region

We are an institution thatoperates in only one country

Which best describes

your institution?

The research presented in this report is based on an international State Street survey of 134 senior

executives in the pension fund industry. The survey was conducted by the Economist Intelligence Unit in

August 2014. Respondents from 15 countries participated in the survey, with the majority being drawn

from the US, UK, Australia and Canada.

State Street 2014 Survey of Pension Funds – Geographic Focus

Source: State Street 2014 Asset Owner Survey, conducted by the Economist Intelligence Unit. Pension fund respondents.

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ASSET OWNERS

17%

31%

52%

Superannuation fund

Private sector pension orretirement system

Public sector pension orretirement system

Please select your institution type

Both DB and DC

62%

Defined benefit (DB) 20%

Defined contribution

(DC) 18%

Which best describes your institution?

Just over half of respondents came from public sector pension funds, nearly a third from private sector

pension systems, and 16 percent from superannuation funds. Most respondents came from

organizations that oversee both defined benefit (DB) and defined contribution (DC) funds.

State Street 2014 Survey of Pension Funds – Institution Types


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ASSET OWNERS

Three-quarters of pension funds surveyed will ramp up their risk appetite as the search for

returns intensifies in a tough investment climate

Trend 1:

Getting Hands-On With Investment Risk


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ASSET OWNERS

Q8. Do you expect your institution's investment risk appetite to:

3%

20%

55%

57%

41%

19%

2%

2%

2%

Over the nextyear

Over the nextthree years

Increase significantly Increase slightly Stay the same

Decrease slightly Decrease significantly

Survey Insights

• More than three

quarters of

respondents in

(77 percent)

expect their

institutions'

investment risk

appetite to

increase over the

next three years

• Nearly 60% see

such increased

appetite for risk

even in the next

12 months

Pension Funds Ramp Up Their Risk Appetite


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ASSET OWNERS

Pension funds face a dilemma. Many say they would like to derisk their portfolios, but the current

environment requires them to weight their investments towards higher growth/higher risk strategies.

Success therefore requires them to strike a new balance on risk and return.

Interview Quotes – The Risk-Return Dilemma

Pension funds are stuck between an equity market that's been on a good run for many years and

a bond market that still looks expensive. Then on top of that you have all the Central Bank

interventions pressing rates down. Funds want to maximize their returns and at the same time try

to minimize risk. We are in territory we haven't been in before.

Robin Diamonte, Chief Investment Officer, United Technologies Corporation

The low interest rate environment has definitely been a real challenge for many investors,

including CalPERS. Right now, our required rate of return is 7.5 percent. To achieve this in the

current climate, we have followed a fairly growth oriented portfolio strategy. If you add up all our

equity and growth oriented assets, our private equity and public equity positions, it comprises

almost 62 percent of the plan’s total assets. It’s a relatively high allocation to growth assets for a

mature plan.

Wylie Tollette, Chief Operating Investment Officer, CalPERS

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ASSET OWNERS

Based on the survey results, private equity will be the biggest winner from a surge in

alternatives investment by pension funds. Emerging market investments are also

becoming more important.

Trend 2:

Big Bets on Alternatives


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ASSET OWNERS

Q4. Please indicate whether your institution plans to make any

changes to its relative allocations. Survey Insights

• 60% of

respondents see

an increased

allocation to

private equity

• Direct loans are

the second-most

desirable

alternative asset,

with 54% of

respondents

expecting to

increase direct

loan allocations

• One quarter of

respondents are

making first time

investments into

hedge funds

60%

54%

45%

39%

29%

20%

2%

6%

2%

2%

3%

3%

5%

7%

3%

9%

25%

27%

28%

28%

45%

50%

22%

29%

6%

5%

5%

1%

21%

20%

Private Equity

Direct Loans

Real Estate

Infrastructure

Hedge funds (singlemanager)

Fund of hedge funds

Will increase existing allocation

Will decrease existing allocation

Will invest for the first time

Will make no change to existing allocation

N/A (no allocation and no plans to invest)

Pension Funds’ Alternative Asset Allocations


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ASSET OWNERS

Q4. Please indicate whether your institution plans to make any changes to its relative allocations.

58%

50%

50%

44%

44%

38%

12%

15%

8%

16%

8%

21%

Direct loans

Hedge funds(single manager)

Real estate

Infrastructure

Private equity

Fund of hedgefunds

A Shift in Allocations – Top Three Countries

50%

43%

29%

29%

25%

14%

4%

7%

21%

7%

18%

25%

Private equity

Direct loans

Infrastructure

Real estate


Fund of hedgefunds

Will increase existing allocation

Will invest for the first time

75%

54%

46%

39%

11%

7%

7%

7%

4%

36%

36%

Private equity

Direct loans

Real estate

Infrastructure

Fund of hedgefunds


Australia UK US


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ASSET OWNERS

Expectations for allocations from:

4% 3% 6% 10% 13%

22% 20% 21%

16%

49% 46% 41%

16% 17% 14%

0%

25%

50%

75%

100%

UNHWInvestors

InstitutionalInvestors

PensionFunds

Increase significantly

Increase slightly

Not change

Decrease slightly

Decrease significantly

Don't know

Why?

53% 35%

13% Portfolio performancechallenges

Portfoliodiversification issues

Improved terms

Why?

Belief No. 1: Strong Flows

Source: State Street 2014 Hedge Fund Survey, conducted by the Citigate Dewe Rogerson

47%

39%

15% Dissatisfaction withperformance

Dissatisfaction withfees

Low risk tolerance

NOT FOR DISTRIBUTION

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ASSET OWNERS

Q2. Where do you see investment opportunity for your

institution increasing or decreasing? Survey Insights

• Vast majority

(81%) of

respondents see

investment

opportunity in

developed

markets

increasing

• Nearly two-thirds

(62%) are bullish

on emerging

markets

opportunities

19%

11%

5%

62%

52%

21%

16%

35%

65%

3%

7%

1%

1%

1%

1%

Developed Markets

Emerging Markets

Frontier Markets

Strongly increasing Slightly increasing

No change Slightly decreasing

Strongly decreasing N/A

Momentum of Regional Investment Opportunities

Source: State Street 2014 Asset Owner Survey, conducted by the Economist Intelligence Unit.

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ASSET OWNERS

Insourcing changes the game as the vast majority of pension funds surveyed plan to

manage more of their assets in-house

Trend 3:

DIY on Asset Management


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ASSET OWNERS

Q6. Over the next three years, do you plan to:

Survey Insights

• The great majority

(81%) of pension

funds expect to

increase the

internally

managed

proportion of their

portfolio

• The right

insourcing

strategy can

deliver substantial

cost savings

• Insourcing also

enables pension

funds to get

closer to their

assets and to

reduce agency

risk

19%

81%

Make no change to the proportionof your portfolio that is managed in-

house

Increase the proportion of yourportfolio that is managed in-house

Insourcing: Asset Owners Become Asset Managers


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ASSET OWNERS

Q11. Will your institution seek to make any of the following

changes within the next three years? Survey Insights

• A greater number

of funds and

investment

schemes is the

most widely

expected change

(76%). This

points to greater

complexity.

• 53% of

respondents see

increased

deployment of

lower-cost

investment

strategies

Evolution of Pension Funds’ Investment Tools and Strategies

76%

53%

43%

14%

2%

2%

6%

18%

22%

45%

51%

68%

Number of funds/schemes

Usage of lower-cost strategies toachieve desired investment outcomes

Number of technologyplatforms/software solutions

Number of external consultants for yourinvestment portfolio

Will seek to increase Will seek to decrease Will make no change


Most Institutional Investors Understand the Value of Data

16 Source: State Street 2014 Data and Analytics Survey, conducted by Longitude Research

2

18

34

47

It is a low-level strategic priority(near the bottom)

It is a mid-level strategic priority

It is the most important strategicpriority

It is a high strategic priority (near thetop)

How do most senior leaders at your institution view the importance of

investment data and analytics relative to other major strategic priorities?

(% of all respondents) “Our investment in

data and analytics capabilities

are a source of competitive

advantage for us”

23% 43%

Strongly agree

Somewhat agree

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Source: State Street 2014 Data and Analytics Survey, conducted by Longitude Research

Asset Managers Are Farther Along on the Data Journey Than Asset Owners

17

23

38

40

32

35

34

Starter

Mover

Innovator

Asset Owner Asset Manager

• Most asset managers are

confident in their data

abilities: 40% of asset

managers are Data

Innovators, versus only

23% who are Data

Starters

• Asset owners are less

confident: 34% are Data

Innovators, almost the

same proportion as Data

Starters (32%)

Data Starters, Movers and Innovators

(% respondents, grouped by asset owners

an asset managers)

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40

50

9 2

Reporting requirements will increase, but our data capabilities will cope adequately

Reporting requirements will increase, and our data capabilities will struggle to cope

Reporting requirements will largely remain unchanged from today

Reporting requirements will ease

Source: State Street 2014 Data and Analytics Survey, conducted by Longitude Research

Many Believe They Will Struggle to Cope With More Regulation

18

55% Asia-Pacific =

Which of the following statements best characterizes your expectations for regulatory reporting

requirements over the next 3 years?

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ASSET OWNERS

Pension funds set a new threshold for performance from their asset managers

Trend 4:

The Relationship With Asset Managers Evolves


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ASSET OWNERS

Q5. Have you experienced any of the following over the past

year with respect to your external managers? Survey Insights

• Understanding

the risk-adjusted

performance of

external

managers is the

most common

challenge for

pension finds –

58% struggle with

that

• Aligning interests

and incentives in

the second-most

common

challenge (52%)

• Justifying the cost

of external

mangers is a less

common issue

(29%)

Pension Funds’ Relationship With External Managers

18%

16%

10%

8%

6%

40%

36%

28%

28%

23%

Gaining a complete picture of risk-adjustedperformance

Ensuring their interests are aligned with ours

Conducting due diligence post-hire to ensuremanagers are meeting our expectations

Conducting due diligence when hiring newmanagers

Justifying the fees

Major challenge Minor challenge

Source: State Street 2014 Asset Owner Survey, conducted by the Economist Intelligence Unit.

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ASSET OWNERS

Q5. Have you experienced any of the following over the past

year with respect to your external managers? – Ensuring their

interests are aligned with ours Survey Insights

• Ensuring external

managers’

interests are

aligned with those

of pension funds

is a particularly

strong concern

among Australian

respondents

• This is also

perceived as a

challenge by

pension funds in

the UK

Concerns About Alignment of Interest with External Managers

27%

14%

7%

31%

39%

29%

Australia

UK

US

Major challenge Minor challenge


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ASSET OWNERS

Pension funds are facing a choice to either continue to purchase asset management services or to build

the capabilities in-house.

Interview Quotes – The Build-or-Buy Dilemma

“Instead of saying here’s a product for you to invest, they (asset managers) are collaborating to

develop investment solutions that are more appropriate for your particular needs.”

“Can we insource some components of the process and outsource other components?

Traditionally we’ve bought the whole car. Maybe we need to buy the engine or buy the brakes or

buy the engineering capability and just build the car ourselves.”

Richard Brandweiner, CIO, First State Super”


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ASSET OWNERS

Changing Investor Demands and Profiles

Multiple responses accepted.

Source: State Street 2014 Asset Manager Survey, conducted by FT Remark

20%

23%

57%

47%

35%

47%

32%

47%

19%

30%

43%

37%

0% 20% 40% 60% 80% 100%

Germany

Japan

Canada

UK

US

Australia

Strongly agree

Somewhat agree

To what extent do you agree or disagree: Changing client demands are causing a fundamental

shift in our overall business strategy?

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ASSET OWNERS

Expected Sources of Growth: Investment Strategies – Australia

Source: State Street 2014 Asset Manager Survey, conducted by FT Remark

80%

7%

3%

3%

0%

0.0%

7%

Multi-asset solutions

Traditional actively managed equity

Traditional actively managed fixed income

Passive equity

Alternative mutual funds

Passive fixed income

Other

Which one of these investment strategies do you think will contribute most to your business

growth over the next three years?

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ASSET OWNERS

Half of pension funds surveyed will prioritize improvements to governance as regulatory

scrutiny intensifies

Trend 5:

Fortifying Governance


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ASSET OWNERS

Q12. What level of priority will your institution place on

strengthening the following areas over the next three years? Survey Insights

• Regulatory

compliance is top

of mind for

pension funds –

61% see it as

high priority and

another 35% as

medium priority

• Strengthening

governance is

high on the list for

over half of

pension funds

• Data

management is

another high

priority for 55% of

respondents

61%

55%

51%

24%

10%

35%

39%

41%

43%

46%

4%

6%

8%

33%

44%

Regulatory compliance

Data management

Overall governance

Cybersecurity

Contingency planning (ie, disasterrecovery, business continuity)

High Priority Medium Priority Low Priority

Pension Funds’ Top Priorities for Improvement


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ASSET OWNERS

Pensions will increasingly need an approach that emphasizes oversight, transparency and disclosure.

Regulation is certainly a factor in this trend. The increased use of complex alternatives may also require

pension funds to bring in more professional trustees or specialist advisors.

Governance With Expertise

Pensions funds have had a lot of discussions with the regulator about the expertise of board

members… The pension funds agreed that they should have more specialists with asset and risk

management skills on the board.

Peter Borgdorff, Director, Pensioenfonds Zorg en Welzijn (PFZW)

25% of respondents say that the increasing complexity of portfolios

will require them to make changes to the composition of their trustees.


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ASSET OWNERS

Focus for the Future

To succeed in today’s complex investment environment, pension funds will need to develop strategies

in each of the following five areas:

Manage the Risk Budget Across the Portfolio

Invest in specialist tools and capabilities to improve analysis across multi-asset portfolios. 1

Master the New Investment Mix

Learn how to blend alternative investments with low cost strategies to strike a new balance on risk

and return.

2

Think Strategically on Insourcing

Understand where your in-house talent can add more value. Create the operating model to

optimize in-house asset management.

3

Develop Strategic Partnerships With Key Managers

Many pension funds are concentrating on developing fewer but deeper relationships with their

asset managers.

4

Professionalize Governance

Ensure professional oversight on risk and governance. Make better use of expert trustees and/or

specialist advisors.

5


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ASSET OWNERS

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developments may differ materially from those projected.

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Expiration date: 11/30/2015

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