Pension funds should adopt private equity as asset class

Opinion and Analysis

Workers erect a new signboard on the National Social Security Fund. The new law that was enacted last year comes with huge contributions and reporting obligations. Photo/FILE 

By Kenneth Kaniu

It is acknowledged globally that alternative assets such as private equity are able to boost portfolio returns.

In fact, over the long term, they provide higher risk adjusted returns and are less susceptible to the impacts of short term vagaries such as inflation and fluctuating interest rates.

Benchmarks such as the MSCI have consistently shown that these asset classes tend to outperform traditional assets such as equities and fixed income in the long term.

 

There are two types of pension funds in Kenya: the first is the historical Defined Benefit scheme, where both employees and the employer make contributions into a fund with the employer bearing ultimate investment and financial risk as he promises to pay the employee a guaranteed benefit/return.

The newer and more popular scheme with employers is the Defined Contribution scheme. Here employees and employers make joint contributions, but with the investment and financial risk borne by the employee thus absolving the employer of any obligation to make good of any deficits that may be occasioned by the occasional spell of bad runs in the investment markets.

Fortunately, for all parties involved, the capital markets in Kenya have over the last few years been solid from the point of view of transactions, turnover and investment performance, leading to fairly strong cumulative returns over the last three to five years.

Performance

With less than five listings on the securities exchange annually, fewer corporate bond issues and a monthly mid to long- term public debt auction, it has become more challenging for pension funds to profitably, invest these funds on a risk adjusted basis so as to generate long term sustainable performance.

Further, the fact that listed securities are not fully representative of the economy means the growth is derived from a concentrated sub set, increasing systemic risk.

Pension funds are not the ‘be all’ solution to this capital structure problem but they do provide an alternative in terms of ability to provide long term, sustainable pools of capital and earn a competitive return from it.

There are definitely some risks involved; there have been instances where private equity funds have either not been successful in raising funds, have not been able to deploy funds in good time into investment opportunities and where they have managed to invest these companies unfortunately some have not done very well.

For pension funds looking to match long-term assets with their liabilities and for those looking to generate strong, stable investment returns relative to the listed equities, private equity as an asset class certainly should warrant further investigation.

Kaniu is chief investment officer at STANLIB Kenya Limited.