Institutional investors warn pension funds not to become shadow banks

The theme of departing banks providing investment opportunities for schemes in direct lending, infrastructure debt and other asset classes has been frequently reiterated over the past few years as capital adequacy requirements have mounted.

Speaking at Pensions Expert's Pension Plan Derisking event on Monday, Ian McKnight, CIO at the Royal Mail Pension Plan, said the opportunities were divided into two camps – buying assets that banks no longer want, and stepping into a bank's shoes to provide financing to borrowers.

"I've seen 50-100 managers in the market, probably, who will tell you a reasonably compelling – on first pass – story about one or either of those investment ideas, but you need to tread very carefully. You need specialist teams."

He added: "There's lots of different ways of playing it but you'd need a very compelling case to wade in because, in my experience, banks don't tend to sell you something cheaply."

This followed warnings from the Bank for International Settlements last week to pension funds about the "danger" of institutional investors putting their risk aversion to one side to invest in unfamiliar assets.

In his opening remarks to delegates, Danny Truell, CIO at charity the Wellcome Trust, appealed to pension funds not to become shadow banks.

"There are a few opportunities where banks are selling things – there are a number of areas which I'm fairly scared by, because people don't really understand what they are doing." He gave the example of buying catastrophe insurance, which he described as "flavour of the month".

"The bottom line is [that] to be competitive against banks you have to have a couple of things which pension schemes don't have." The first being a "genuinely long-term" investment horizon, and the second being a high credit rating, Truell said.

The AAA-rated charity's endowment has invested in long-dated energy derivatives, traditionally the preserve of banks but now presenting an appealing supply and demand mismatch, in the institution's view.

Truell added: "The reason that we can do that, which most people can't, is because of course I don't post collateral... I don't know of many banks left with a AAA credit rating."

But delegates also heard the argument for investing in such assets through pooled vehicles. John Harrison, senior adviser at investment consultancy AllenbridgeEpic and adviser to four local authority pension funds, said there were only a few local government funds that had the resources to pursue individual opportunities.

He added: "We want to shift the burden of generating the return onto the providers of the products that we are buying into. We are very open to giving them quite a bit of scope to do that."