Schemes reveal their reappraisal of the risk-reward characteristics of assets and how they have adjusted their portfolios, in the second instalment of the Intelligent Thinking survey
The majority of schemes polled by schemeXpert.com and Pensions Week have turned their backs on domestic equities in their search for attractive returns and reduced risk and volatility.
Pension fund manager, £1.4bn scheme: “We have systematically reduced exposure to conventional bonds. We are also in the process of looking at migrating our developed-market equities into dividend-growth mandates, recognising the majority of returns in low-growth markets will come from dividends.”
Member-nominated trustee, £4bn scheme: “Falling gilt yields – with the resulting reduction in discount rates and increase in liabilities – have resulted in increased diversification into higher return-seeking assets.”
Member-nominated trustee, £500m scheme: “We have reduced our UK equities allocation, but global equities have maintained. We have also made greater investment into infrastructure to obtain a regular income stream. Derisking of investments has been the main focus of the way we invest.”
Trustee, £500m scheme: “Our attitude is unchanged. We are still largely invested in equities.”
This year’s Intelligent Thinking survey revealed the current low-growth, low-interest rate environment has led schemes to take a fundamental reappraisal of the risk-reward characteristics of their assets.
This has resulted in many readjusting their portfolios and moving away from the traditional asset classes.
Schemes that are able to invest in a wider range of uncorrelated assets stand a better chance of reducing the risk of volatility in their portfolios.
“The lower-growth environment has caused us to re-question our commitment to equities as the bedrock of growth assets,” said the investment director at a £4.2bn public sector scheme.
“The credit crisis has made us consider return, risk and liquidity of all potential investments very carefully.”
Pension schemes with combined assets of £30bn took part in the survey, as well as a wide range of investment consultants, whose companies advise on more than £8trn of assets worldwide.
The consultants who took part have been advising their clients of the benefits of moving their investments away from an overdependence on the traditional pension scheme portfolio of equities, bonds and cash.
They have also been calling on schemes to evaluate assets based on their risk, reward and liquidity profiles.
Fixed income challenges
Low interest rates are especially challenging for UK schemes, which use gilt yields as the basis to discount their liabilities.
Within fixed income portfolios, clients are allocating to emerging market debt and – to a lesser extent – high yield
This means a succession of events – such as continued bouts of quantitative easing and the flight to safety from the eurozone crisis – has pushed yields lower, and liabilities higher.
“Most pension funds want to increase their bond allocations strategically further, but are conscious of price,” said John Belgrove, principal at Aon Hewitt.
“Many are tactically choosing to wait for better opportunities right now and meanwhile diversifying their growth assets to improve the risk-reward trade-off.”
While it has often been argued the current low-yield environment is artificial, many consultants warned against complacency – calling on schemes to consider readjusting their fixed income allocations to allow for a long-term low-yield environment.
Scheme representatives who took part in the Intelligent Thinking survey were increasingly looking at a wider range of fixed income assets, which could offer better returns than gilts and corporate bonds.
Some of these assets have the advantage of being more liquid and therefore more flexible. This characteristic is in higher demand among schemes as they consider future movements in interest rates.
Peter Ball, head of investment solutions at JLT, said: “Within fixed income portfolios, clients are allocating to emerging market debt and – to a lesser extent – high yield.
“Secured loans, while a little less liquid, are also proving very popular.”
Emerging markets boost
The Intelligent Thinking survey also revealed the increased interest in emerging markets among pension schemes shows no sign of abating.
While developed economies continue to limp along, the emerging markets are expected to generate comparatively higher growth over the coming years
“These economies will play a bigger part of our investment,” said a member-nominated trustee at a £500m scheme.
“Emerging market economies are attractive, but only insofar as investing in global companies with emerging markets exposure.”
When it comes to favouring emerging market equities over debt, there was a rough split between the schemes.
One respondent felt equity offered better value than debt, while another preferred debt, saying equity was often more volatile and had a tendency to be globally correlated.
“While developed economies continue to limp along, the emerging markets are expected to generate comparatively higher growth over the coming years,” said Phil Edwards, principal at Mercer.
He said though the economic slowdown was very much a condition of developed markets, the description did not suit emerging markets.
“With no end in sight for the eurozone debt crisis, many emerging market countries appear downright resilient,” he added.
“Growth and debt dynamics are two key themes supporting our continued favourable view of allocations to both emerging market debt and equity.”
For some schemes, the higher growth rates of emerging economies and the potential for currency appreciation was a big attraction.
But other respondents felt the promotion of emerging markets assets had been so strong over the past decade that many investments would now be expensive.
Next week’s instalment of theIntelligent Thinking survey looks at what investment strategies are finding favour in the low-growth, low-interest rate environment.
