EUROPE - Pension funds in Cyprus holding cash in local banks - currently highly exposed to the Greek sovereign debt crisis - have already reduced their allocations to the asset class and are taking new measures to ensure liquidity should the banks run into serious trouble.

Aon Hewitt, in its latest pension fund survey, estimates that Cypriot pension funds have allocated as much as much 60% of their capital to cash deposits, with the vast majority being deposited in local banking institutions.

But recent events in Greece, and the growing fear that Cyprus could also slide into default, have forced investors to rethink their investment strategies.

As a result, investments in short-term cash deposits in Cypriot banks have started to decrease in recent months.

According to the Central Bank of Cyprus, deposits held by financial intermediaries fell from €7.5bn in May to €6.1bn in June.

Philippos Mannaris, country manager for Cyprus at Aon Hewitt, said: "Obviously, if bankruptcy would mean a loss of capital for pension funds, then the impact would be tremendous given the 60%+ allocation to cash.

"However, local banks are quite well capitalised, and the risk of capital loss on cash deposits is, in our opinion, minimal."

Pension funds are now looking at other investment strategies, such as pooled money market pooled funds, or diversifying cash deposits to more banking institutions.

Local pension plans are also taking a major step, exploring the option of investing in alternative asset classes.

Marinos Gialeli, general manager at Hotel Employees Provident Fund, said: "The risk premium we are seeing at the moment comes from the cash deposit held by several pension funds in Cypriot banks and the very high returns this cash deposit provides.

"If we face an important issue, we will have to adapt our investment strategy consequently and spread the risk in our portfolio.

"This could be done through higher allocations to other asset classes, including alternative assets such as hedge funds, private equity and infrastructure."

Last week, ratings agency Moody's downgraded the island's two main banks - Marfin Popular Bank and Bank of Cyprus - over their exposure to Greek debt.

Moody's said the primary reason for its decision was the high level of direct exposure to Greek government bonds.