Britain’s well developed pensions industry, with some £3 trillion ($4 trillion) in assets under management, is undergoing big changes that are heavily impacting retirement schemes’ investment allocations.
Pension funds, asset managers and regulators in Asia Pacific should keep an eye on these developments as they may have to cope with some of the same issues, say industry experts.
The biggest changes are taking place in the UK’s defined-benefit pension sector. Funds there are grappling with multiple issues, including a continuing de-risking of portfolios and a rising need to match cashflows to liabilities.
To do this, DB funds are increasingly using external fiduciary managers to meet their needs, as well as increasing their exposures to passive equity strategies and private debt. In addition, a growing call for sustainable investing is making itself felt in the investment strategies of these funds.
Many of these trends are as yet nascent, but evolving in Asia. As such, it’s worth asset owners in this region understanding what their more mature peers in the UK are doing.
An over-arching mega-trend among the UK’s DB pension funds has been an effort to ‘de-risk’ portfolios. The impact of this is starkly clear in publicly available data. Equity exposure among DB funds has steadily fallen for over a decade while bond allocations have risen, according to the latest Purple Book, published annually by the UK Pension Protection Fund (see table below).
Their weighted average allocation to equities halved from 61.1% in 2006 to 29% as of end-2017, while their bond exposure roughly doubled to 55.7% over the same period. Additionally, the funds’ average hedge fund allocation rose from zero in 2008 to 6.7%.
“A lot of schemes are getting to the point where there’s not a lot of de-risking left to be done,” said Alastair McDonald, UK head of portfolio advisory at Willis Towers Watson. “But there’s a few more years of this to play out.”
Partly as result of de-risking, DB pension schemes in the UK have seen an increase in funding levels in recent years, according to the PPF. The average ratio of assets to liabilities of schemes in the PPF 7800 index stood at 94.5% on May 31, up from 85% in May 2009.
The improvement in funding levels is also down to factors such as rises in long-term real interest rates and a continued slowdown in the rate of increase in life expectancy, according to Steven Dicker, chief actuary at consultancy PwC.
Alongside the move towards de-risking has come an increasing focus on generating cashflows that better match fund liabilities. Recent improvements in the funding levels of DB schemes in the UK means they can concentrate more on cashflow-driven investing (CDI), a variant of liability-driven investing.
More than half of British DB pension funds are cashflow-negative, noted Mark Johnson, head of institutional client management at Legal & General Investment Management (LGIM). That is, they are making less money from investments and contributions than they pay out.
Johnson cited two reasons for this. First, DB schemes are entering a decumulation phase, in which they pay out more in benefits than they receive in contributions or returns.
In addition, new UK legislation has created greater choice for members, prompting the transfer of money from DB to DC schemes, which can cause liquidity issues. All-told, £10.6 billion was pulled out of DB schemes in the first quarter of 2018, according to the UK’s Office of National Statistics. That was a three-month record. In total, £36.8 billion was withdrawn last year.
The rising importance of cashflow management has caused pension asset allocations to change in the past three years to reflect that need, noted Johnson.
The response has been to buy cashflow-distributing assets—such as investment-grade corporate bonds, and ‘secure income’ assets, such as infrastructure, real estate and private credit. At the same time, funds are retaining some riskier, higher-yielding assets, notably equities, emerging-market debt and high-yield bonds, with a view to helping their portfolios to approach full funding.
HSBC’s UK DB pension scheme is a good example of this shift. The £28 billion fund is gradually moving assets from its return-seeking portfolio into its matching portfolio, chief investment officer Mark Thompson told AsianInvestor.
It aims to complete this de-risking process by 2025, when it will have in place a “target-matching” portfolio largely containing long-dated cashflow-type investments, with no exposure to equity or growth assets.
This is taken from an extended feature that appeared in the June/July issue of AsianInvestor magazine.