Europe's pensions want to boost allocations to various alternative investment classes--primarily infrastructure, but asset managers face myriad challenges in delivering high returns, a new report says.

Plans to increase exposure to infrastructure over the coming three to five years exist at nearly 70% of European pensions, according to Cerulli Associates' survey of asset managers in Europe.

The main driver behind institutions' quest for alternative strategies is their need for diversification, as many of Europe's largest investors recognize the yields from their core holdings are inadequate, and that markets for some mainstream assets are pricey.

But alternative managers still face myriad challenges winning new institutional business.

Some pensions are co-investing directly, thereby largely bypassing asset managers in some lucrative asset classes. In addition, Europe's insurers must weigh up the value of alternatives in light of proposed high capital charges under Solvency II, and recent returns from some alternatives classes that seem at best mediocre.

The reporting rigors insurers will face under Solvency ll are an additional pressure on alternative managers that insurers select, making full transparency and regular data updates essential services these days for all managers to make headway with European insurers.

Fees for alternative strategies may deter some institutions from allocating, but European pensions tell Cerulli that charges only rank mid-pack in the list of alternative fund attributes they examine. Risk management is more important.

"Pre-crisis, being 'alternative' often denoted a willingness in a manager to take risks trying new things--hedge funds making illiquid investments using side pockets, for example," said David Walker, director at Cerulli and lead author of the report. "That was then, but now, 'alternative' for an institution mainly means a manager generating returns while controlling risk. Managers should explain to Europe's institutions what they are good at, what they will not do, and stick to it," he added.

The hunger for non-mainstream assets is driven partly by a realization by institutions that prevailing yields on core debt holdings alone will not generate the returns they need to honor their own promises to customers. However, Laura D'Ippolito, senior analyst at Cerulli, notes: "The hunt for yield is not limited to the alternatives space. European institutions are also looking for further diversification within their fixed-income investments, and are considering strategies such as emerging market debt, bank loans, and credit."