Analysis: Equities are making a comeback as optimism about stocks is growing. Fears over inflation have pushed investors away from fixed income, and bond yields upwards.
For defined benefit schemes, rotating out of fixed income and into equities would represent a departure from a historic decline in equity exposure.
Scheme interest in domestic equities has been diminishing for some time. Research by UBS Asset Management shows that while an average of 53 per cent of scheme assets were made up of UK equities in 1997, funds carried a mean exposure of just 16 per cent in the asset class in 2016.
Against this trend, new research from Bank of America Merrill Lynch indicates that investors' overall equity allocation has jumped to a two-year peak of a net 55 per cent overweight. Their allocation to bonds has dropped to four-year lows, with a net 67 per cent underweight.
I don’t see people running for the hills from bonds and going into equities at the moment
Giles Payne, Capital Cranfield
Still, the maturity of DB schemes makes it difficult to envisage a move from fixed income towards equities. And given the extent to which defined contribution schemes are already invested in growth assets, is there much room for further investment?
Fixed income currently offers poor value
DB pension schemes in the UK have a combined deficit of £450bn based on the funding targets used by trustees, according to consultancy PwC. Former pensions minister Ros Altmann sees allocation to equities as an essential part of a scheme’s ability to pay its benefits.
“If you’ve got a deficit, and you haven’t got a sponsor with unlimited resources, you will never fix the deficit with bonds,” she said. According to Altmann, schemes should take on more risk with equities and other asset classes, such as hedge funds and venture capital.
Tamsin Evans, head of multi-asset at consultancy P-Solve, said the lack of value in certain strands of fixed income speaks for a greater equity allocation.
Evans, who advises both DB and DC schemes, said: “In the shorter term, we favour equities above all else at the moment.”
“Of the options available, equities are the best of the evils,” she added. “Investment grade credit, and to a greater extent now high yield [credit] are really, really unattractive from a valuation point of view… they are so, so overpriced.”
According to Evans, her company is advocating selling down corporate credit allocations in favour of equities, in order to sustain risk levels.
Equities are suited to the young
However, in the experience of Steve Delo, managing director of Pan Governance, global enthusiasm for stocks over bonds is not currently being shared by DB schemes.
“I don’t see much bond-to-equity switching happening in DB pensions,” he said. “This would increase expected volatility in a world where it is all about reducing risk and variability of outcomes.”
Any investment consultant giving advice to do this “would be running rather a lot of career risk”, he added.
Giles Payne, client director at professional trustee company Capital Cranfield, is also yet to observe a switch from bonds to equities at scheme level.
“I don’t see people running for the hills from bonds and going into equities at the moment,” he said.
Payne noted two attitudes to equity investment from a DC perspective. He observed an aversion to capital loss among young investors and wariness over equities.
From a pure investment point of view, however, Payne said the lengthy time horizon for DC schemes allows for equities to ride out volatile periods and deliver long-term returns.
“I think definitely equities for younger contributors to DC is on the cards,” he said.
Hybrid funds may be the answer
Trustees are constantly striking a balance between growth requirements and a scheme’s obligation to pay out benefits. A halfway solution has emerged, in the form of hybrid funds.
Where should tomorrow’s schemes allocate their assets?
In 1997, globalisation and increased investor sophistication powered a bull market that was meant to stretch beyond the confines of a regular business cycle.
Ben Gold, head of pension investment, north at consultancy Xafinity Punter Southall, estimated that about 10 to 15 per cent of his clients are now invested in products that concurrently offer growth and fixed returns.
“The fund will give you both equity exposure and something like [liability-driven investment] or credit exposure as well, so they’re often actually increasing their bond exposure, but without sacrificing equities,” he said.
