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It is common knowledge that UK occupational defined benefit (DB) pension schemes have been slowly reducing their equity holdings over a number of years, but the results of our most recent Big Schemes survey suggest that this trend has accelerated significantly in the last year.
"While the big schemes’ allocation to equities has fallen by around half over the past five years ... the magnitude of the change in the last year suggests that there are other forces at play"
Every year, we analyse the UK’s private sector DB schemes with assets of over £1 billion, looking at scheme type, asset allocation, deficit contributions and adviser fees. This year’s survey saw a large fall in the average equity allocation of the UK’s biggest schemes, with the average allocation falling by around a third compared to last year’s survey (from 23% to 16%). While the big schemes’ allocation to equities has fallen by around half over the past five years (from 30% in 2014), as schemes have been steadily de-risking their investment portfolios, the magnitude of the change in the last year suggests that there are other forces at play.
One of the primary reasons for this trend is the low-yielding investment environment, with schemes increasingly willing to consider a range of alternative asset classes to increase their expected rate of return. We are seeing a significant increase in interest in asset classes such as real estate debt, infrastructure debt and other alternative risk premia strategies, as schemes become more prepared to accept risks such as illiquidity in order to generate higher investment returns.
The other reason for the step change in equity allocation is the level of transfer value payments being made from DB schemes. All but 5% of the schemes in our survey experienced an increase in transfer value payments over the year, with around one third of the schemes seeing a threefold increase. This accelerates the de-risking process, as growth assets (particularly liquid equity investments) are often those chosen to be sold to support transfer activity.
Transfer value payments generally improve DB scheme funding positions too, as the amount paid out is usually less than the reserve held for funding purposes, and certainly less than any agreed long-term objective. As a result of the high level of transfers, many schemes in our survey will have experienced a significant improvement in funding position. This will have reduced the investment return required to reach their long-term objective, allowing de-risking to be accelerated further.
A similar comment can be made about the slowdown in longevity improvements seen in recent years, which will also have driven schemes along their de-risking journey at a faster pace than originally expected. For schemes de-risking, equity investments are often the first port of call. These investments are generally liquid (i.e. cheap and easy to sell) and still commonly represent the biggest single growth asset exposure for schemes. The strong performance of equities over recent years will also mean that they may be prioritised when any disinvestments are needed.
Having said that, for the largest schemes, reducing equity exposure may not be as straightforward as it is for the smaller schemes. This can be due to the size of the transactions needed relative to market liquidity, but can also reflect other difficulties. For example, where investments are managed in-house, reducing equity exposure may also mean reducing the size of the equity management team. This can be a difficult decision to make.
With DB schemes continuing to mature – almost half of the membership of the big schemes are now retired members – there is no doubt that this trend is set to continue. The key challenge for DB schemes over the coming years will be generating positive investment returns while having sufficient liquidity to meet an increasing level of cashflow payments – investment strategy decisions will only increase in importance.