Pension funds seek riskier, illiquid bets to make returns they need

* Struggling to make returns they need conference

* Low bond returns creating a bubble in other markets

* Schemes forced to buy less liquid assets

By Carolyn Cohn

EDINBURGH, March 14 (Reuters) British pension funds arecoping with low bond yields and high share prices by seekingriskier investments, in a hunt for the returns they need to meettheir obligations to pensioners.

Collectively managing at least 2.5 trillion pounds ($ 3.69trillion), pension funds are reeling from six years ofmoney-printing by central banks globally, which has depressedyields so much that some bonds even cost investors money to holdthem.

Speakers (Milan: BEC.MI news) and delegates at a National Association of PensionFunds conference this week warned that pension fund investmentinto more volatile equities is fuelling a stock market bubble,where share valuations have risen to record levels even thoughcorporate earnings have been disappointing.

The other side of the low interest rates (environment) iswe are now seeing enormous risk-taking and the risk of bubbles,Steven Maijoor, chairman of the European Securities and MarketsAuthority told the conference.

More and more schemes are being tempted to look foralternative assets to invest in, which are often more risky andilliquid, including infrastructure bonds, direct corporateloans, catastrophe bonds and emerging market debt.

Conference attendees were even discussing frontier debt, theriskiest of emerging market bonds.

A typical pension fund would likely have around half of thegrowth assets portion of its portfolio in stocks, a quarter inreal estate and the remaining quarter in other alternatives,such as hedge funds, infrastructure or direct lending, said JohnWalbaum, head of investment consulting at Hymans Robertson.

In a world where bonds are yielding inflation minus 1percent, if you can get something which yields a bit more thanthat, its the way to go, said Chris Hitchen, chief executiveof railway pension fund RPMI.

Record (LSE: REC.L news) high stock markets are even making hedge funds, knownfor taking risks, nervous of high share valuations. Manny Roman,chief executive of Man Group (LSE: EMG.L news). the worlds largest listedhedge fund, told the conference:

Bubbles are complicated they go up, its very hard topredict if and when they burst. I would urge anyone to be verycautious.

Britains FTSE 100 flirted with record highs of 7,000 points earlier in March, while the U.S. Standard & Poors500 is just shy of its all-time high. In the UK, FTSE 100firms, have so far on average missed full-year profitexpectations by 1.1 percent, Thomson Reuters StarMine datashowed.

Among more exotic investments, emerging market corporatedebt with a triple-B investment grade rating offers a 100 basispoint yield premium to euro zone corporate debt with the samecredit rating, fund managers say.

UK property prices produced double-digit gains in 2014. Buthigher costs, as charged by hedge funds, can dent these returns. and so can an increase in thecost of regulatory capital needed to hold these investments.

There is also a greater chance that funds may not be able tosell these assets quickly if they need to, because ofrestrictions placed on banks following the financial crisis.

On the corporate (debt) side, you have seen a drop of about80 percent in liquidity since before the crisis, said AlainKerneis, a managing director at BlackRock (NYSE: BLK news) .

The number of dealers quoting prices in euro zone investmentgrade corporate bonds has dropped to 3 from 8-9 five years ago,fund managers said.

But they also said there were new pockets of liquidity, suchas exchange-traded funds (ETFs), which were proving cheaper andmore liquid than traditional equity index futures.

And provided pension funds are diverse in their assetallocation, they can cope with some illiquid assets becausetheir investments are long-term.

You just have to make sure you have enough liquid assets tomake your payments, said Walbaum.($ 1 = 0.6784 pounds) (Additional reporting by Simon Jessop in London; Editing byElaine Hardcastle)

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