Despite wide-spread speculation that pension schemes are increasing their investment in bonds, the preliminary findings of a new survey by Mercer Investment Consulting show the average allocation remains the same as last year at 35 percent.
The survey of more than 425 UK defined benefit pension schemes with more than GB177 billion in assets revealed that the average allocation to bonds has increased by just four percentage points in the last three years, a news release said.
At the same time, pension funds are maturing and the proportion of schemes open to new entrants has fallen to 39 percent from 42 percent last year.
Andy Green, Head of Investment Strategy at Mercer, said, “While it may seem surprising that bond allocations have remained stable at a time when pension schemes are maturing, trustees are concerned about the level of current bond yields and are finding other investment markets more attractive.”
The survey shows that the average allocation to equities has dropped only slightly – from 63 percent in 2005 to 62 percent this year. Investment in UK equities has decreased from 37 percent in 2005 to 35 percent this year, while allocations to overseas equities have risen by one percentage point to 27 percent.
“Though the UK equity market offers potentially higher dividend yields than other developed markets, stock concentration in the UK means returns are dominated by the performance of a few companies or sectors,” Mr Green said. “Trustees are offsetting the effect of concentration by reducing their exposure to UK stocks and allocating more funds to international equity markets.”
Eight percent of funds have adopted a capped UK equity index benchmark, which limits exposure to the largest stocks, as an alternative way to offset the effect of stock concentration, the study found.
The trend towards investing in overseas equities has been supported by an increased use of currency hedging, from 14 percent of schemes in 2005 to 20 percent this year. On average, the proportion of currency risk that is hedged is 65 percent.
According to the survey, less than 4 percent of schemes still follow a discretionary peer group benchmark strategy. Two-thirds of assets (66 percent) are invested with active managers, while 34 percent are invested in track indices, the study found.
Alternative investment strategies
The survey shows the use of alternative investments continues to increase, in particular active management or so-called ‘alpha’ strategies, Mercer said. On average, 7 perecnt of schemes now invest in hedge funds and 7 percent employ an active currency manager. For larger schemes, the figures increase further, with almost 10 percent investing in hedge funds and around 15 percent using an active currency manager.
Mr Green commented: “Investment in alternative assets such as hedge funds and active currency is likely to increase further this year, as trustees have become more comfortable with these strategies as a way to diversify risk and enhance performance.”
The survey also identified that one in ten schemes is expected to consider introducing some form of cash-flow matching or liability-benchmarked strategy in 2006, either through physical bonds, swaps or liability-driven mandates.
“There is significant interest among pension schemes in managing interest rate risk through liability-benchmarked investment mandates. However, many schemes are finding the current price of long-dated bonds and their derivatives unattractive,” Green said.
Mercer will be releasing the full results of its survey on pension fund liability and asset allocation in Europe in April.