European pension funds shift out of equities

European pension funds have continued to cut equity allocations, according to research by Mercer.

Its European asset allocation survey, which looked at more than 1,200 European pension funds with combined assets of more than €750 billion, found that plans in the UK shifted out of equities over the last 12 months, with the average equity allocation falling from 43% to 39%, down from 68% a decade ago.

According to the research, UK schemes have traditionally been among the most equity-heavy in Europe, but now sit behind Belgium, Ireland and Sweden in terms of equity exposure. 

The research also found:

  • The proportion of schemes across Europe that allocate some part of their assets to a liability hedging (or LDI) mandate increased from 15% to 26% over the last year, with such strategies becoming commonplace in the UK and the Netherlands.
  • Nearly half of the schemes surveyed now have an allocation to alternatives, with around 75% of UK schemes claiming an alternatives allocation.
  • Almost 20% of schemes across Europe now have an allocation to growth-oriented fixed income, with emerging market debt and high yield debt the most popular asset classes within this category.
  • Diversified growth funds have become a popular means of accessing a diversified exposure to a range of return drivers, with almost 20% of schemes having an allocation to this type of strategy.
  • Around 30% of schemes expect to reduce their domestic allocation and almost a quarter of schemes expect to reduce their non-domestic equity exposure.
  • Around a quarter of respondents expect to increase their allocation to alternatives, with only 7% expecting to reduce the size of the portfolio.

Nick Sykes, European director of consulting in Mercer’s investments business (pictured), said: “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.”

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Pat Race, UK head of Mercer Investments, added: “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.”