European pension funds warm to LDI as derivative allocations grow
The proportion of European pension funds ruling out implementing liability-driven investment (LDI) strategies has plummeted over the last year as awareness increases, research shows.
Mercer’s annual European asset allocation survey found increasing allocations to matching assets, typically used in derivative-based LDI strategies.
Overall, the consultant’s research, conducted across 1,200 schemes in 14 European countries, found a return towards the alternative asset class, after seeing a fall in the year previous.
It also reported a slowdown in the falling exposure to equity markets, with the average allocation only falling by 1% across Europe.
In the UK, the reduction was 2 percentage points. However, a slower rate than previously seen, given average equity allocations, fell by 27 percentage points over the last 10 years.
A decrease in exposure to domestic equities continued as European funds diversify, and was matched with an increase to emerging markets.
Almost half of the European funds now have allocations to these markets, a 13 percentage point increase from last year.
The predicted shift of scheme fixed income allocations towards corporate bonds has also yet to materialise on a macro level.
However, Mercer singled out Germany, the Netherlands and Sweden as markets where this was prominent.
The UK’s shift to using index-linked instruments continued, with the proportion of fixed income assets matching inflation now 69%, up from 55% over the last two years.
Overall, the funds allocated 13% to domestic equities, 21% to non-domestic and 52% to fixed income.
Alternatives grew to 9% while property made up 3% of allocations. However, the impact of these asset classes varied significantly across the 14 countries.
Swiss funds allocated 14% of assets to real estate, while Danish funds 20% to alternatives.
In comparison, French schemes only allocated 1% to each and held 22% in domestic equities.
Belgium still remained the country with the highest average allocation to equity, followed by Ireland and Sweden.
Norway and Germany led the way in terms of fixed income, with schemes allocating more than 65% of assets.
Within alternatives, 41% of the funds had allocations to real assets, such as core property and infrastructure, with an average allocation of 6%.
Growth-orientated fixed income allocations were held by 27% of schemes and mainly consisted of emerging market debt and high yield.
Almost a fifth (17%) held hedge fund allocations. However, Mercer reported no fund-of-funds searches for the second year running, as schemes tire of the double-layer fee approach and allocate directly.
Mercer saw a 3 percentage point increase in the proportion of schemes conducting LDI strategies from last year, but stressed this was dominated by schemes larger than €500m.
Only 12% of funds said they had not considered the strategy at any level, a figure that hit 29% last year.
Mercer’s European director of strategic research, Phil Edwards, said that, despite the relatively small increase in LDI use, the management of risk remained a concern for trustees.
“The complexity and governance challenges around LDI may have acted as a barrier for smaller schemes in the past,” he said.
“Given the range of pooled and delegated LDI approaches now available, we expect to see the gap in take-up between large and small schemes reduce over time.”