Increasing demand for asset allocation strategies

The need to match long-term liabilities with similar maturity low risk assets, coupled with the objective of generating sufficient investment returns, is at odds with current market conditions, experts say.

Toby Nangle (pictured), director of asset allocation at Barings, said pension funds are looking to transfer money to long-dated bonds – liability driven investments (LDI) type of strategies – if they are very well funded. But most of them are not.

“Where they are not well funded they have to embark in recovery strategies, which will vary from plan to plan, but typically will have an LDI component as well as a volatility-controlled growth asset. We do multiple pitches a week for schemes looking for these types of solutions” he added.

George Muzinich, president of Muzinich & Co, said government bond prices are likely to drop over time.

He warned: “There is currently no single solution on how best to solve the problem of simultaneously maintaining long-dated, liability-matched government securities while also maintaining adequate yields to meet minimum return requirements."

He added: “The previous strategy of increasing returns by heavily investing in assets such as equities and alternatives has proved a disappointment.”

Managers believe government bond markets are increasingly pricing in very low interest rates for a very long time.

John Stopford, head of fixed income at Investec, said investors who have long dated liabilities – such as pension funds – need to decide whether they want to lock in what are potentially very expensive funding costs or whether they should look at ways to mitigate their costs.

The options available to them range from partially managing interest rate risks, to looking for alternative sources of returns in the fixed income market which might boost performance. These include allocations to corporate bonds, inflation-linked bonds and currency exposures.

Stopford added: “Pension funds’ views on liability matching are becoming different from the early days. There is much more focus now on the cost and timing of risk reduction. Schemes also look for ways of mitigating costs by generating additional returns or capturing some beta opportunities.”