UK pension funds will continue to reduce their allocation to equities as they cut back on risk taking, according to a study by Pension Corporation and Engaged Investor magazine published on July 03, 2011. The study, of 197 occupational pension fund trustees with aggregate liabilities of at least £50bn ($80bn), finds that 73 per cent plan to cut back on equities in the next few years, with 77 per cent planning to reduce overall risk in their pension fund.
UK pension funds have been gradually reducing their allocation to equities in the past decade from 74 per cent in 2000 to 55 per cent in 2010, according to Towers Watson. The equity exposure of UK funds remains the highest of all the large markets; compared with 49 per cent in the US, 37 per cent in Japan, 33 per cent in the Netherlands and 28 per cent in Switzerland. But a decline in equity allocations is common, with the net overall allocation across the largest pension fund markets down by 13 per cent in the past five years, as pension funds diversify into alternative asset classes, which now account for 19 per cent of all portfolios.
Despite the drive to rein in the risk, UK pension fund trustees are under pressure to improve the performance of their investment portfolios in order to make up funding shortfalls. As at the end of May, UK private sector pension funds were in deficit by £79bn in aggregate, according to JLT Pension Capital Strategies, despite a 12 per cent growth in assets over the previous 12 months to £1,010bn.
According to the Engaged Investor/Pension Corporation study, tackling a deficit is the top priority for 47 per cent of trustees. One solution is to add more capital into the scheme; 55 per cent of trustees plan to ask for an increase in contributions from their sponsor of at least 10 per cent at their next round of actuarial valuations.
Businesses injected £29bn into defined benefit schemes in 2010, but are continuing to suffer in the wake of the economic recession; UK GDP growth in the first quarter of 2011 was a fragile 0.5 per cent. If higher company contributions are not forthcoming, pension fund trustees will come under renewed pressure to secure stronger growth from investment portfolios ?? but without being able to rely on equity markets, which are increasingly being viewed by consultants as too volatile.
The most popular risk reduction strategy, under consideration by 56 per cent of UK trustees, is liability driven investment (LDI), which involves using bonds and derivatives (principally interest rate and inflation swaps) to reduce the risk of funding levels declining. However, as with any risk management strategy, while the downside is reduced, so too is the upside, limiting the ability of trustees to make up the shortfalls.
Better investment diversification and wider use of alternative strategies are other techniques UK pension funds are adopting to improve their risk profile without hampering their ability to repair funding deficits. This trend has fuelled interest in fiduciary management, under consideration by 9 per cent of trustees, whereby investment management is outsourced to consultants or asset managers. It has also boosted the absolute return industry, which has seen a significant increase in product launches for the institutional sector; Deutsche Bank forecasts $185bn will flow into Ucits III absolute return funds on a global basis over the next year.
Given that 58 per cent of trustees expect their schemes to be fully funded within 10 years, the demand for investment strategies that can deliver risk adjusted, consistent returns is likely to continue to prove a big growth area for the asset management industry that serves UK pension schemes. The increased complication that these strategies present to non-professional trustees will be a stumbling block; 55 per cent of those surveyed by Engaged Investor/Pension Corporation cited ??the increased complexity of the role? as a reason why they should be paid for pension fund work. With paid independent trustees an increasingly common feature of most trustee boards ?? 53 per cent now have one ?? the ability to understand and adopt more sophisticated investment strategies is also growing.
