UK - The idea that UK defined benefit pension funds will be able to switch out of equities and into long-dated fixed income to cut risk is fundamentally flawed, according to KPMG.

The strategy is "just not going to work" the firm's head of investment consulting says.

Research by the firm's investment consulting team has found that demand for long-dated bonds will outstrip supply by up to four times - meaning funds will have to consider alternative investment strategies.

"The theory that pension funds will transfer investments out of equities into sterling long-dated bonds to reduce their exposure to the equity market and reduce their risk profile once the value of these equity holdings increases to cover their deficits is fundamentally flawed," KPMG said.

The comments come a week after the Organisation for Economic Cooperation and Development said new accounting standards may have set up a "vicious circle" of bond demand from pension funds, most notably in the UK.

"There is a widely held belief that if pension funds reach the point where the value of their equity holdings increase to cover their deficits, they will swap out of equities into bonds," said UK head of investment consulting Patrick McCoy.

"Our research shows clearly that this will not be possible as the supply cannot meet demand."

KPMG estimates UK DB schemes have around £750bn (€1.1trn) in assets, with many of them in deficit.

When they attain a fully-funded position, it is expected that these funds will seek to cut their equity exposure to rebalance their asset allocation and reduce their risk profile, KPMG notes.

It estimates if the industry sought to transfer all its equity holdings into sterling long dated bonds at this point, the likely requirement would be around £515bn - although there are only an estimated £100-150bn available.

"Wholesale swapping into long dated sterling bonds as a low risk strategy to plug deficits is just not going to work for UK pension funds with defined benefit schemes," McCoy added.

"The bonds are not available. The squeeze in the bond market is likely to continue to suppress yields. Pension funds will have to look at alternative investment strategies focused on more diversified portfolios or use complex financial instruments."