Aon Hewitt reports that the trend for medium-sized UK pension schemes to move away from investment in equities – and UK equities in particular – towards alternative and liability matching assets, is likely to intensify significantly during the next 12 months to three years.
The findings are taken from the Aon Hewitt Mid-Market Survey, which looked at the asset and liability strategies being implemented or considered by defined benefit (DB) pension schemes worth between £10m and £500m. By number of schemes, this group represents over 60% of the UK pension landscape.
The results show that interest is growing among medium-sized schemes in investment strategies that aim to match scheme liabilities as they seek to de-risk their assets in the uncertain economic climate. These Liability Driven Investment (LDI) strategies were once regarded as the preserve of just the largest, most sophisticated, pension schemes. However, innovation in product availability among specialist managers has allowed these solutions to become readily accessible to smaller investors at a sensible fee. Supply has stepped up to meet demand.
Key findings on scheme investment issues, included:
• Some 59% of medium-sized UK pension schemes anticipate a further reduction in investment allocations to UK equities.
• Almost 45% of the same sample also intends to reduce allocations to global equities.
• There is significant interest in increasing allocations to diversified growth funds or those with a more dynamic capability (39%).
• Greater interest was expressed in increasing allocations to corporate bonds (34%) compared with government bonds (28%).
• 42% of mid-market UK pension schemes intend to increase allocations to index-linked government bonds.
• Two in five mid-market UK pension schemes intend to increase allocations to tailor-made LDI solutions via LDI funds.
John Belgrove, principal consultant at Aon Hewitt, said:
“Ten years ago, Liability Driven Investment (LDI) was in its infancy and regarded as a niche strategy pursued by a few larger and more sophisticated UK pension schemes. It is now an established core strategy, and has become a capability offered by many specialist fund managers. In a low yield environment, entry timing remains a challenge but while early adopters have fared well, our research suggests that small and medium-sized pension schemes are now benefiting from the lessons learned by the pioneers of LDI.
"Today's solutions enjoy more user-friendly documentation, improved operational infrastructure and counterparty diversification, and they are more dynamic in responding to the volatile market circumstances which offer opportunities as well as threats. As the fund management industry continues to refine its capabilities, best advice and execution will be critical to future success."
John Belgrove continued:
“More broadly, this development is also evidence of "3D investment" - de-risking, diversification and dynamism among medium-sized pension schemes in the UK. Increasing levels of liability matching assets, decreasing equity allocations and diversification into alternative return-seeking assets - all combined with a greater appetite for asset allocation agility - remain deep structural trends for DB schemes.
"This is all the more impressive given the severe headwinds that most pension schemes have been facing and which may have resulted in many concluding that change was too costly or too difficult. Instead, it indicates that most medium-sized schemes remain focused on their longer term goals and are continuing to seek sensible opportunities to de-risk rather than be distracted by short-term market turbulence. There is still a long way to go, but one implication of this is that if yields did rise significantly, then demand for new LDI solutions might explode.”
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