Data crunch: Equity outflows from UK defined benefit schemes have gradually softened this year, which could be a sign that trustees are seeing greater value in equity investing longer term, writes Broadridge’s Hal La Thangue.
Trustees have redeemed shares to shore up ravaged portfolios with alternative sources of growth and sought to stabilise funding ratios with synthetic liability-driven investment solutions.
While structural change will not halt equity derisking, the torrent of outflows appears to be abating. This is an asset class that still has something to give
As schemes age further and many close, generating contractual cash flows to pay pensions is paramount, a characteristic equity does not possess. With the Covid-19 pandemic, we have yet another event that has stressed the importance of diversification and liability hedging as markets tumbled and interest rates fell.
As the chart illustrates, equity outflows from UK DB schemes have been persistent since the end of 2012, with both active and passive strategies suffering. When compared with the fate of LDI, the difference is stark.
While the stage may be set for renewed vigour in equity derisking amid heightened volatility, the first half of 2020 has continued a recent trend — equity outflows are slowing.
Looking at the data on a year-by-year basis, the pattern becomes clear. After accelerating in 2017, when there were almost £40bn of equity outflows, redemptions have gradually softened and the pace of derisking has slowed. The same theme appears to resonate this year, with a modest £7bn of outflows in the first half, compared with £13.5bn over the same period in 2019.
This can partly be explained by the lower base of equities in the average DB portfolio, but the strength of change suggests there is more at play, and that schemes are seeing greater value in equity investing longer term.
A global theme to highlight — pensions are more circumspect about how they construct equity portfolios, considering the sources of risk and drivers of return to improve intra-asset class diversification.
Simply put, this often means using low-cost index products for efficient, developed markets exposure; harnessing factor-based products (such as smart beta) to systematically capture return generators typically exploited by managers; and reserving active allocations to those strategies where there is sufficient ability to add value.
This last point is particularly important given the struggles of active managers as a result of underperformance and high fees – if a scheme pays to go active, it wants the underlying strategy to be one where alpha potential is present. This may be based on targeting inefficient markets, such as small-cap or emerging economies, or style.
One style-based strategy that has garnered attention among UK private schemes is global high conviction, where a manager constructs a concentrated portfolio of 20-30 shares unconstrained by geography. These intuitive strategies picked up assets in the early part of the year as Covid-19 struck.
Schemes are likely to need active managers to help them navigate emerging opportunities — Chinese financial markets and sustainable investments, for example.
While structural change will not halt equity derisking, the torrent of outflows appears to be abating. This is an asset class that still has something to give.
Hal La Thangue is senior consultant in the global insights team at Broadridge Financial Solutions
