UK - A UK-based pensions consultant has urged defined benefit pension schemes to abandon their traditional investment approach for a risk-based investment approach where assets are more closely matched to scheme liabilities, as officials believe there is still too much emphasis on equities.

In a paper entitled Strategic Asset (Mis)Allocation, Institutional Investment Advisors (IIA) argued most UK DB schemes still hold too high a proportion of their assets in equities - a move which it said offers a poor economic hedge for the underlying liabilities.

Moreover, equities also create the conditions for a very volatile solvency position, according to Paul Roby, director at IIA.

"Trustees and sponsors of pension funds have not been given good advice in terms of strategic asset allocation," said Roby.

"From 2003 to 2007, employers tried to get out of a hole by investing in equities but they failed to take gains off the table. They have got to look on equities as a speculative activity and actively trade them."

According to the IIA paper, a high equity allocation creates a significant contingent financing risk on the sponsoring employer, which in a downturn could result in reduced dividend payments, and in extreme cases threaten the ongoing viability of the whole business.

The paper suggested DB schemes with significant equity allocations should target eventual fund self-sufficiency over a medium-term time horizon, although this would require changes to their investment strategy, and a revised schedule of contributions.

To achieve this, schemes should establish a dynamic asset allocation programme to achieve a gradual reduction in their equity allocation, claimed IIA.

The paper also claimed asset allocation should be focused on assets which are more closely matched with the scheme's liabilities and which produce more predictable cashflows over time.

This would include traditional bond-type assets, and also other asset types, such as high-quality structured credit investments producing Libor-plus returns, while interest rate and inflation derivative overlays should be used when the pricing is acceptable, according to IIA.

Meanwhile, Towers Perrin has calculated that the £44bn (€50.8bn) combined pension deficits of FTSE100 companies as at the end of May could have been reduced by two-thirds to £15bn if these companies had taken steps to de-risk their pension plans at the end of 2007.

This would have required them to switch half their equity holdings to bonds in December 2007, said Mark Duke, head of pensions at Towers Perrin.

"Some FTSE100 companies took steps to de-risk their pension plans before the crash in asset values but many did not. Putting in place automated triggers that will switch to de-risked assets when market conditions are right will help prevent a repeat of the damage caused by the credit crisis," he added.

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