Schemes up proxy matching assets to avoid low-yield bonds

Mercer’s 2014 European Asset Allocation Survey found the expansion of the LDI market was relatively modest in 2013, with the proportion of respondents using the strategy increasing 3 percentage points to 29 per cent. This compares with a 11 percentage point increase in 2012.

Phil Edwards, European director of strategic research at the consultancy, said as part of the long-term derisking trend in the UK defined benefit market, LDI is becoming more important.

“But the proportion of schemes using LDI hasn’t increased dramatically,” he said. “That partly ties in with improving [market] sentiment.”

The amount of schemes with the strategy in place also varies between large and small schemes, 45 per cent of schemes with over €500m (£408.3m) in assets have an LDI programme compared with only 25 per cent of smaller schemes.  

Of the respondents without LDI, 19 per cent said it was because bonds yields were too low.

“A feeling still exists that yields are very low and schemes don’t want to lock in at these levels,” Edwards said. “Schemes are looking for alternatives, some of these income-generative, inflation-sensitive alternatives.”

The survey found 41 per cent of respondents had an allocation to real assets with the average allocation to the asset class being 6 per cent.

Many schemes were seeking long-term inflation-sensitive income streams from assets as the number of schemes allocating long-lease property in the year rose.

According to the survey, 34 per cent of European respondents had an allocation to core property, with the average allocation of schemes amounting to 7 per cent. Only 8 per cent of schemes have invested in high lease-to-value property, with the average allocation being 5 per cent.

UK schemes have become more interested in opportunistic property including real estate debt and second-tier property.

Edwards said: “Since we have seen such strong markets in the London prime real estate market, what we have seen is parts of the secondary universe undervalued and ignored, and we think there is an opportunity there.”

Nick Spencer, head of alternatives at the consultancy arm of Russell Investments, agreed that schemes are trying to get more out of their property allocations by diversifying the types of assets in which they invest by moving it into second-tier property.

“The second type of diversification we are seeing is for some of these longer-term, more cash flow-oriented structures and strategies, such as long-lease in particular, but also using some of the debt strategies,” Spencer said.

But he warned schemes should be cautious about the matching qualities of such assets.

“It is not a pure liability hedge because it is not an exact match, and it will have credit and other risks attached to it,” Spencer said. “They are almost a third type of asset trying to enhance the return over our matching part of the portfolio.”

Plans across the UK have increased their exposure to inflation-linked bonds relative to fixed government bonds, reflecting a desire to improve matching characteristics, the survey states.

“Schemes are looking for more flexible approaches that can be more dynamic and responsive to market condition. And also perhaps less exposed to a rising yield environment that we may be heading into,” said Edwards. “This is where we have seen this interest in multi-asset credit come through in the last year.”

UK schemes have also slowed their pace of exit from equities to 2 percentage points last year, from an average of 4 percentage points over the past five years.

“It is partly markets rising which supports asset values and adds to the weight the in equities,” said Edwards. “But also improving sentiment and improving feeling among institutional investors that things are getting better, leads to people feeling more confident.”