Deep-pocketed pension and insurance funds may increase their investments in equities and other riskier assets in emerging and developing countries as they struggle with historically low interest rates in industrialized markets, the IMF said on Tuesday.
Pension plans of Canada, Germany, Japan, Switzerland, Britain and the United States, which typically rely on traditionally safe investments such as bonds, are in danger of being unable to cover what they owe beneficiaries, in part because of low interest rates, the IMF said in its Global Financial Stability Report.
The full report will be released on Sept. 21.
Pension and insurance vehicles are being left underfunded because traditionally safe investments in industrialized countries are yielding little or nothing due to the historically low interest rates, the IMF said.
One way to try to avoid any shortfall would be to become more aggressive and move into riskier assets, said Laura Kodres, assistant director of the IMF's monetary and capital markets department.
Until now pension funds have been reluctant to increase holdings of risky assets. "So far it appears they are paralyzed like deer in the headlights of an oncoming car, afraid to move," Kodres said.
But in an IMF survey, about one-fifth of respondents expected higher risk exposure in their portfolios in the next three years. Investing in emerging markets was seen as a way of increasing portfolio returns without taking on excessive risk.
The report said state-owned wealth funds currently hold some $4.7 trillion in assets while international foreign exchange reserves total about $10 trillion. Together, the value of wealth funds and foreign exchange reserves amount to about one-fourth of assets under management of private institutional investors, the IMF said.
Since the 2009 global financial crisis sovereign wealth fund managers have increasingly diversified their portfolios by increasing investments in equities and alternative assets, usually financed by cash, and to a lesser extent fixed income holdings, the IMF said.
New IMF estimates put core reserves needed for balance of payments purposes in emerging market economies at $3.0 trillion to $4.4 trillion, leaving $1.0 trillion to $2.3 trillion potentially available to be invested beyond the traditional mandate of reserve managers, in a manner more like that of sovereign wealth funds.
The IMF said alternative assets such as commodities, real estate, infrastructure and hedge funds were increasingly catching investors' attention, but so far there was little evidence of a significant shift in that direction.
While insurance companies are required to hold the bulk of their assets in safe, low-yielding investments, they may become more aggressive with the rest of their portfolio, which could lead to investing more aggressively in smaller emerging markets or alternative assets, the IMF said.
"Even though it appears these are more risky from the outside, once you've put them into the portfolio it can actually lower the risk of the portfolio," Kodres said.
One concern with alternative assets is investors may not be able to exit them easily in times of turmoil, the IMF said, adding that this was a time for emerging market countries to strengthen their financial systems.
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