Ongoing diversification within the portfolios of German institutional investors has not shifted overall bond and equity exposure, according to Towers Watson, which surveyed pension providers with nearly €130bn in combined assets.

The consultancy found that pension institutions were looking for returns in government bonds from peripheral Europe and the emerging markets, as well as high-yield bonds and loans.

It said equity investors were seeking “strong regional diversification”, with an increased home bias reflected in a euro-zone equity overweight. 

However, bonds still account for the lion’s share of the average German portfolio (59%), followed by equities (27%) and alternatives (10%).

Based on the current asset allocation of the surveyed institutions, Towers Watson calculated an average expected return of 3.9% per annum over the next decade.

In a statement on the study ‘Pension Risk Management and Allocation of Pension Assets 2014’, Nigel Cresswell, head of investment consulting at Towers Watson Germany, said: “German companies should consider whether a rather conservative approach is in line with their individual return expectations.”

He said German investors were already accepting the low-interest-rate environment as the new normal rather than an exceptional situation.

But he warned that a low discount rate and a change in the interest rate curve “still contain a high risk potential for the liabilities side of investors”.

Cresswell said he was convinced “the unused possibilities for diversification have a huge potential for improving returns”.

His suggestions include direct investments in alternative asset classes, as well as a broader use of smart beta strategies in that space.

Further, he criticised the disuse of governance structures to make return drivers more efficient and adjust them to the long-term return/risk targets of investors.

“Up until now, governance was seen as a stand-alone concept determined at the beginning of the investment process and is static in nature,” Cresswell said.

But he predicted that increased complexity of investments would lead to an expansion of the governance concept by an “organisational design” approach.

He added that, in portfolio construction, qualitative models for risk/return assessments were already replacing quantitative models, whose weaknesses were revealed in the wake of the financial crisis.