Schemes set to enter 2023 in a ‘challenging position’

A report from European asset manager Amundi, together with Create-Research, has revealed that pension plans are still facing structurally high inflation in 2023, which they will need to get to grips with.

Even though central banks have been raising interest rates to dampen rampant price increases, high single-digit inflation is likely to persist throughout next year, even if it tails off slightly from the giddy heights of 2022. For example, the UK recorded a 41-year high back in October, before dropping slightly in November and December.

As a result, Amundi believes that pension plans will need to target real assets in private markets for inflation protection, and global equities for total returns, while passive investing will remain critical for cost efficiency in a world of low returns.

The traditional 60/40 portfolio needs to incorporate new features, such as higher structural inflation

Monica Defend, Amundi Institute

But the 48-page report, ‘Pension funds: reorienting asset allocation in an inflation-fuelled world’, said there were “too many open-ended and unknowable risks” facing pension plans.

In particular, UK pension plans face a challenge in 2023, the report added, highlighting the following five factors as significant issues for them to tackle:

• Around 75 per cent of them are in negative cash flow situation: more money going out than coming in.

• They are overweight in bonds.

• Some are overweight in bonds while they are moving towards insurance buyouts, but that means taking big hits from rising rates.

• Just when they need higher returns to compensate for inflation, they are forced to be underweight in inflation-protected assets because of their liquidity features.

• Their liability-driven investment strategies are under review, just when their investment options are very restricted.

According to professor Amin Rajan of Create-Research, who led the project: “The key question for pension funds is how to redesign their portfolios in a world of structurally higher inflation, less accommodative central bank policy, and higher geopolitical uncertainty.”

The Amundi/Create-Research report was based on responses from 152 pension plans from 17 jurisdictions, managing €1.98tn (£1.73tn) of assets combined.

What keeps pension plan managers up at night?

When asked about the most likely scenario for the post-pandemic global economy, 50 per cent of survey participants said they predicted a “stagflation” scenario: too hot in terms of inflation and too cold in terms of growth.

But 12 per cent also anticipated the “roaring twenties” scenario, in which price pressures from the supply bottlenecks ease notably alongside robust growth, driven by productivity gains from innovation that also keeps inflation low.

Diversification has once again failed when most needed, causing pension plan managers to reconsider their asset allocation strategies.

For example, the need for portfolio flexibility and “keeping some powder dry” to invest will drive dynamic investing, redrawing the traditional 60/40 approach, according to 58 per cent of respondents.

There is also a sign of a revival in value investing. With high correlations between equities and bonds, 42 per cent believe diversification based on risk factors will gain traction again.

Monica Defend, head of the Amundi Institute, said: “Monetary policy tightening and the risk of economic recession means financial markets have become very volatile, including traditional safe assets.

“The traditional 60/40 portfolio needs to incorporate new features, such as higher structural inflation, less accommodative central banks, economic fragmentation, and emerging long-term themes like industrial transformation, value chain reshaping, and strategic autonomy.”

Defend added: “In this respect, high dividend equities, thematic investing and real assets become crucial.”