“UK pension schemes faltered at the end of the year. The aggregate funding level of the PPF Index decreased from 94.7% at the end of November to 93.9% at year end. Despite buoyant equity markets boosting pension scheme asset values, real and nominal gilt yields drifted lower again over the month. However, looking back at 2017, it could be considered a purple patch for UK schemes. Aggregate funding levels have risen from around 80% to around 94% and the proportion of schemes with funding deficits fell from 75% to 66%. Although some of the improvement is due to the adoption of the latest Purple Book dataset in November, 2017 was a year in which return-seeking assets materially out-performed liabilities.
“New year is a time for reflection and change. So, should it be ‘New Year, New Strategy’ for pension schemes that find themselves at a better starting point than last year? We don’t propose ‘big bang’ changes to investment strategy; we expect risk assets to perform well again in 2018, meaning pension schemes can again benefit from exposure to these markets – particularly equities and alternatives. We’d suggest a typical pension fund adopts a modest bias towards these asset types – but be wary of pockets of overvaluation in certain private markets. It can be tempting to make a big change to portfolios at the turn of the year – but the changes should befit the scheme status and the current investment opportunities – don’t be suckered in like the couch potato that signs up for the expensive gym on January 1st.
“Schemes should look at de-risking as funding levels improve, but affordability should be considered when doing so. For instance, tilting a portfolio towards buy and hold investment grade credit is a popular de-risking strategy – and theoretically appealing because it gives the pension scheme better visibility on future cash inflows and total return. However, today’s lofty credit market valuations mean the return being ‘locked in’ is low. We suggest schemes hold a balanced portfolio – equities, LDI, and private market cashflow generative assets all have their place – and buy and hold credit should be phased in as schemes can afford to do so, i.e. when funding levels improve or when better entry levels arise. When making asset allocation decisions, schemes should consider the risk, return and cashflow of each asset and not fall in to the trap of fixating on just one of these elements.”
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