‘Mindset shift’ in FTSE 100 battle to reduce DB risks

While the move into matching assets continues, many schemes are trying to eke out returns from diversified growth funds, multi-asset credit and the illiquidity premia from real assets in order to help quell worsening deficits.

Nearly two-thirds of FTSE 100 company pension scheme assets are now held in bonds, according to data from consultancy JLT Employee Benefits.

In the year to March, the average bond allocation of UK blue-chip schemes increased 5 percentage points to 60 per cent of total assets.

There is more interest in growth [opportunities] which are lower risk than straight equities

Charles Cowling, JLT

Over the past six years average bond allocations across this cohort of schemes has increased by 15 percentage points as schemes have sought to match liabilities via bonds and liability-driven derivative instruments.

Sixty-one per cent of FTSE 100 companies now hold more than half of their assets in bonds.

Charles Cowling, director at consultancy JLT Employee Benefits, said he had observed a “shift in the mindset” around derisking running parallel to the decline in DB provision across the FTSE 100.

Cowling said: “Everything is pushing for the closure of DB schemes, and it’s therefore just a matter of time.

“Once you psychologically change your time frame from ongoing to being sometime in the next 20 years, that changes behaviour and… outlook. [People] are looking at opportunities to derisk all the time.”

Derisking routes

Derisking into bonds may be optimal for a sponsor’s risk reduction but deteriorating deficits over the past 18 months have forced many schemes to continue running investment risk.

In the year to March, FTSE 100 deficits increased £30bn pushing the aggregate deficit for the index to £89bn, and in their most recent annual report and accounts more than half reported significant funding contributions.

“The only way [companies] can get the sums to add up is by taking more risk in the investment strategy, but we’re seeing more evidence of different types of derisking,” said Cowling.

“You’ve got LDI as an absolute risk-reducing strategy, but you’ve got more gentle… steps of risk reduction still headed in the same direction. There is more interest in growth [opportunities] which are lower risk than straight equities."

Risk reduction across growth assets

Neil Davies, associate at consultancy Barnett Waddingham, said schemes looking to reduce risk across growth assets were heading into diversified growth funds, multi-asset credit opportunities and targeting illiquidity premia in property and infrastructure holdings.

“The DGF-type approach is still very popular, although that has some interesting funds which maybe don’t work quite as well… a lot of schemes are reviewing whether they’re taking the right amount of risk in that area,” he said.

Davies added: “The obvious way to derisk is through LDI and bonds, but where you still need those growth requirements you have to look to reduce the risk within that growth portfolio."  

Barry Jones, investment consultant and head of LDI research at consultancy KPMG, said schemes could use a multi-asset credit portfolio as a “powerful tool” to fund the floating leg of LDI swap contracts, which is usually pegged to the London interbank offered rate. 

Jones said: “Multi-asset credit plus LDI is a very neat solution for pension schemes to get a little bit of return into their portfolio but hedge all of those naughty interest rate and inflation risks. [It] obviously takes quite a wide range of guises but in the purest form it tends to be very much a libor plus return.

“With corporate bonds, if you want to actually match your scheme liabilities precisely you would then be limiting your choices of which bonds you use.

"Those two as a fit together has become very popular – changing corporate bond-only portfolios to multi-asset credit plus LDI.”