Pension funds across Europe have continued to reduce their exposure to equity markets over the past 18 months as they bid to limit funding level volatility, Mercer said today.
According to the consultancy's European asset allocation survey, the change has been particularly marked in the UK, where pension funds' average equity allocation has fallen from 43% to 39% over the past 12 months. Just a decade ago, UK funds had 68% of their assets invested in equities, but among the 14 countries surveyed by Mercer, they now sit behind Ireland, Belgium and Sweden in terms of equity exposure.
Rising equity markets over the course of the past year or so have given investors the chance to bank investment gains and reduce their exposure to equities as their funding levels have improved, Mercer noted.
According to its analysis of the survey results, reductions in equity allocations have mainly been used to fund an increase in bond portfolios, while allocations to alternative asset classes such as property and infrastructure have fallen slightly.
Despite this, the firm found that nearly half of the 1,200 schemes it surveyed now have an allocation to alternatives, including around 75% of UK respondents.
Mercer also found increasing numbers of schemes are allocating some of their assets according to a liability-driven investment strategy, where the main goal of investment allocations is to meet current and future liabilities. Over a quarter (26%) of schemes surveyed said they were taking this approach, compared to just 15% a year earlier. This approach is particularly commonplace in the UK and the Netherlands, Mercer noted.
Pat Race, UK head of investments at Mercer, said: 'Against a backdrop of ultra-loose monetary policy, negative real interest rates and a range of unsolved economic issues, pension plans are faced with the challenge of generating positive real returns, while reducing funding level volatility.
'In response, investors are expanding their investment tool-kit, making their strategy more dynamic, and are introducing scenario and stress test analysis into the risk management process.'
The consultancy now expects the trend away from equity to continue over the coming year. Around 30% of schemes surveyed said they plan to reduce the allocation to domestic equities and nearly one-quarter (24%) plan to do so for non-domestic equities.
Instead, schemes are looking to invest more in inflation-linked government bonds (19%) and domestic corporate bonds (16%). Almost one-in-five (19%) are expecting to change their strategy to invest more in multiple alternative asset classes, while just 7% expect to reduce the size of their exposure to alternatives.
Nick Sykes, European director consulting in Mercer's investment business, added: 'Pension schemes across Europe, but particularly in the UK, remain on a path towards a lower-risk investment strategy.
'However, the approach to reducing risk will not simply mean increases to government bond allocations and simple swap strategies. Instead, increasing interest in assets that offer a relatively stable and inflation-sensitive income stream is anticipated, such as ground lease property and infrastructure.
'A broader approach to fixed income investing, to include "buy and maintain" corporate bond strategies and multi-asset credit funds, is also on the horizon. Sophisticated LDI strategies are also proving essential for providing a greater degree of flexibility and responsiveness to changing market conditions.'