Insight's Steve Waddington argues pension schemes will not be lured away from multi-asset funds back to greater equity allocations by stronger market performance, in the latest edition of Informed Comment.
As recently as 1993, 81 per cent of DB fund assets were in equities, the majority of them invested in the UK stock market. Today, only 35 per cent of assets are invested in equities, and the proportion of UK equities has shrunk to less than 10 per cent.
Asset allocation is decided by fundamental shifts in pension fund investment policy, not short-term return chasing
What has prompted this move? Readers will need no reminding: equity market crashes, increased pension scheme maturity and regulatory accounting changes are some of the principle factors.
DB pension schemes are more sophisticated than they have ever been. Gone are the days of investing in equities and crossing fingers that long-term returns will deliver.
Trustees and their advisers are now focused on devising investment strategies that are closely aligned with a scheme’s individual liability characteristics.
The result of these trends is that the asset allocation of DB schemes, whose assets are still valued at more than £1.2tn, has become much more diverse.
Many schemes have looked to derisk and fundamentally rethink their investment strategies, searching for alternative assets that can deliver attractive returns while providing a good match for liabilities or reducing exposure to risk. With equities falling out of favour, what has taken their place?
Today average allocations to fixed income amount to 39 per cent, while the broad 'everything else' category now accounts for 26 per cent of investments.
How the market is changing
Against this backdrop, diversified growth funds are playing a greater role. They evolved from a balanced mandate mix of equities and bonds and have themselves become increasingly sophisticated, with managers investing in an ever-wider array of asset classes and in a more dynamic fashion as they focus on aligning their investment strategies to meet the goals of their clients.
Many DGFs are managed in such a way as to offer, potentially, the best of both worlds: equity-like returns but with much lower levels of volatility. A more diversified and dynamic approach offers the potential to provide protection as, at any one time, some asset classes may be rising while others are falling.
As time has gone on, the objectives of these funds have also evolved to not just offering equity-like returns, but absolute returns with a focus on capital preservation, or to outperform cash within certain volatility ranges. Today there are a wide variety of funds with different goals to suit different investor objectives.
All these funds offer much-needed choice to pension funds.
Sticking to their guns
The equity market rally experienced since 2009, with the FTSE 100 hitting a 14-year high in mid-May, seems to have had little impact on pension funds’ asset allocation choices.
The proportion of investments in equities has fallen despite this increase in the market, down from 50 per cent in 2008 to 35 per cent more recently.
Asset allocation is decided by fundamental shifts in pension fund investment policy, not short-term return chasing.
More important influences are at work: as pension schemes mature, trustees naturally want to reduce exposure to equities and their associated risks. In the National Association of Pension Funds’ view, the rapid pace of private sector DB scheme closures is the key factor at play.
They estimate that if schemes continue to close at their current rate, then DB funds could shift a total of £31bn out of UK equities and into other assets between now and 2020.
Demand for DGFs will remain as long as investors seek equity-like returns but with lower volatility. Appetite for the individual DGFs will depend on their ability to meet their stated objective and their alignment with clients.
The central issue for pension schemes – as ever – is the objective of the fund they are considering, whether that ties in with what the pension scheme is trying to achieve, and whether the fund is realistically able to achieve it.
Steve Waddington is a portfolio manager in the multi-asset team at manager Insight Investment
