Pension funds have had to make highly difficult asset allocation choices owing to changeable markets. Here, Angele Spiteri Paris
looks at asset trends (see also our interviews with three leading figures in pension fund investment)
Asset allocation is at the fore again for institutional investors in Europe. Portfolio construction is described as one of the most important elements of a pension fund’s investment decisions and changes in allocations are taking place once again now that the financial crisis has abated.
European pension funds have marginally retreated from equities markets, but schemes in the UK and Ireland still have a structural bias towards the asset class.
Results of the most recent Mercer Asset Allocation Survey showed that schemes from Ireland and the United Kingdom had equity exposures of 59% and 50% respectively in 2010. Although this still represents a large portion of portfolios, these figures were down from 67% and 58% at the end of 2008. At the end of 2009 the average UK allocation was 54%, which means pension schemes have continued to withdraw from equities.
Across other European markets, equity exposure typically remains low, ranging from around 10% to just above 30%. According to Mercer’s analysis, the larger a pension plan in Europe is, the lower its domestic equities bias.
At 6%, German pension funds had the lowest level of equity exposure.
But according to the Towers Watson Global Pension Asset Study 2010, during 2009 allocation to equities grew significantly in the seven largest pensions markets. This resulted in a sizeable shift from 48% invested in equities in 2008 to 54.4% in 2009, largely as a result of good stock market performance.
The seven largest pension markets are Switzerland, The Netherlands, the UK, Japan, Canada, Australia and the US. Towers Watson, which surveyed 13 of the largest pension funds in the world, found that the value of global pension fund assets increased by 15% during 2009, from US$20 trillion (€15.2 trillion) in 2008 to over $23 trillion. This growth contrasts sharply with the 21% fall in asset values experienced during 2008.
The consultancy said that at the end of 2009, the average global asset allocation of the seven largest markets was 54.4% in equities, 26.9% bonds, 1.3% cash and 17.4% other assets, which includes property and other alternatives.
According to the Mercer figures, Germany, with the lowest equity weighting, had the highest average bond allocation of 83% followed by Norway with a 66% average allocation to bonds.
Many pension plans across Europe increased their strategic allocation to corporate bonds as the yields on government bonds declined and corporate spreads widened during the crisis in 2008.
Mercer believes this move is reversing somewhat as corporate bonds recover from their 2008 and 2009 lows and investors seek other opportunities.
Mercer said: “Many of the themes that emerge from this year’s survey are a continuation of the trends that we have seen over the last couple of years. Pension plans in the jurisdictions that traditionally favoured equities continue to reduce their equity exposure and their domestic equity exposure in particular. Plans elsewhere in Europe have been quicker to embrace a wider range of non-traditional asset classes. Typically, size is a major factor in this process, with the larger plans taking the lead in exploring new investment themes and ideas.”
Roger Urwin, global head of investment content at Towers Watson, says the gyrations of markets during the past few years has presented pension funds with very difficult strategic asset allocation choices.
“During the crisis, some funds sold out of equities to address solvency issues, some drifted out of equities and into bonds by not rebalancing, while others maintained their strategic mix and rebalanced to prior equity percentages. The result overall was a phase of derisking, but not in a measured way and this has largely been reversed as equity markets have rebounded and risk allocations rebuilt.”
Highly changeable market conditions in short periods of time will have caused serious disruptions for pension funds, Urwin says.
“In order to get back on track, they will be reviewing all options, including extra contributions from sponsors, contingent funding arrangements, investment strategy reviews, hedging strategies and pension insurance buy-ins, not to mention changes to benefits structures including fund closures.”Emerging interest
Throughout 2009 one of the hot topics on everyone’s lips was emerging markets.
In keeping with the trend, the Universities Superannuation Scheme expanded its internal emerging markets team earlier this year. Following the new appointments, CIO Roger Gray said: “These appointments will enable us to strengthen further our Asian capability and to take a global approach to the varied opportunities across the full range of emerging markets.”
In another testament to the attraction of emerging economies, the Finnish local government pension fund, Keva, has 12.4% of its €24.7bn portfolio invested in the sector.
In its survey, Mercer said: “The biggest change from last year’s survey is the marked increase in the number of plans across Europe looking to exploit the attractions of emerging market debt. We believe that a number of emerging market economies are in much better ﬁnancial shape than their developed counterparts and so the additional yield on emerging market debt looks attractive relative to the outlook for government debt in many developed countries.”
The vast majority of plans gain exposure to emerging economies through the equity markets, with 28 of the pension schemes surveyed by Mercer having specific emerging market equities allocations of over 25%.
There is a small but growing percentage of funds looking to exploit debt or other markets, the consultant found. Of the respondents, only two pension funds had a specific allocation to emerging market debt while eight said their manager had the discretion to invest in these instruments.Alternatives
According to the Mercer survey, European plans are looking to increase their allocations to a wide range of non-traditional asset classes, in particular debt and inﬂation-sensitive assets.
“Despite some loss of faith in hedge funds from existing investors, European pension plans as a whole are still looking to increase their exposure to these vehicles,” Mercer said.
For example, in the UK, pension plans are seeking to control equity volatility by increasing their allocation to hedge fund strategies. The average allocation to hedge funds has risen from around 9% last year to over 13% in the beginning of 2010.
In the rest of Europe, however, hedge and private equity funds of funds and high-yield debt are more popular alternative asset classes, according to Mercer.
Towers Watson found that other asset classes, especially real estate and, to a lesser extent, hedge funds, private equity and commodities, have grown from 12% to 17% in the last five years.
The firm said that the largest allocations to risky assets occur in the US, the UK and Australia, while the Netherlands, Switzerland and Japan tend to have more conservative investment strategies.
Urwin, of Towers Watson, said: “The global financial crisis was a huge wake-up call and problems of poor systemic design in the industry point to the increased likelihood of further periods of financial distress in the future. While the recovery of markets will be welcomed, it is hoped that it will not stifle recognition of these as major issues for national governments and companies to address. I fear that without exceptional leadership we will have another tough decade in the pension and investment world.”©2010 funds europe