Current trends in the global pension fund sector are primarily being driven by a greater focus on risk management. This is also a local Irish phenomenon that can be seen from our survey results of 150 organisations. This focus is observed in three primary approaches being adopted by investors:
o De-Risking - There has been a modest reduction in the average strategic level of risk of Irish pension funds over the last three years with, for example, the average equity allocation falling from 75% to 69%.
o Liability risk management - There is significant interest in managing interest rate risk with growth in the use of liability - driven investment (LDI) techniques.
o Risk diversification - Pension funds are embracing alternative asset classes and indeed active management (or alpha) strategies where there is strong evidence of consistent added value and indeed where managers do possess true stock-picking skills. The use of alternative investments is likely to become more widespread in the quest for risk diversification.
Close to 68% of defined benefit (DB) respondents fail to meet long term fully funded status. Despite the strong equity market performance over the past three years, Irish pension fund trustees continue to struggle with the long term financial well-being of their pension plans. While assets have performed well, pension fund liabilities have continued to rise at a faster pace than expected due to declining long-term bond yields, enhanced mortality conditions and a strong salary growth environment.
The key objectives of DB trustees and plan sponsors have become shorter term in nature.In setting broad investment strategy for DB plans, 46% of respondents believe their time horizon to be shorter term, that is over the next three years, while 54% believe it to be longer term, or 20 to 30 years out. While 22% of respondents believe that a primary objective is to maximise return and minimise cost to the fund, over 20% of respondents think that improving the solvency position of the fund is a priority while a further 12% believe that stabilising FRS17 or accounting volatility is important. While these numbers indicate that trustees and sponsors are still taking into consideration the long-term nature of pension plan investment, they are being increasingly influenced by shorter term metrics in the guise of solvency and accounting requirements that have pervaded the pensions landscape over recent years.
In terms of setting asset allocation for DB schemes, close to 50% of respondents believe that attempting to better match pension liabilities/increasing bonds is a key priority.
We see this as a very interesting development. An increasing portion of Irish pension fund trustees are migrating away from a market peer group approach to one that has the consideration of liabilities at the heart of the asset allocation decision. A further 23% of respondents believe that the adoption of a customised strategic benchmark is a main priority, again reasserting a trend away from a peer group mentality. With the significant funding and solvency challenges of the past few years, largely emanating from an asset liability mismatch across many pension funds, it is encouraging to see trustees increasingly placing emphasis on arguably the most important part of the pension's balance sheet - liabilities. It is also encouraging to see a big drive on the part of investment managers in developing suitable LDI products that are increasingly available to schemes of all sizes and that help trustees to better match these liabilities and hence manage this risk.
Irish pension plans continue to have significant allocations to Irish equities but close to 30% have plans to reduce their allocations over the next three years.
Despite Ireland representing under 1% of the global equity markets, approximately 20% of survey participants have an allocation of over 20% of their pension assets to Irish equities while 48% have a 10%-20% allocation. Despite the strong relative performance of Irish equities versus their global counterparts, almost 30% of survey participants have plans in place to reduce their allocations in the short to medium term and over 40% of these participants plan to reduce this allocation by 50% to 100%. A further 33% of respondents have an Irish equity allocation below 10% of total fund assets. With the emergence of the euro as a single currency, there has been a broad trend of pension plans reducing their Irish equity exposures. This survey would indicate that this trend is expected to continue - albeit quite slowly.
The level of specialist investment management among Irish pension funds is growing fast.
On the back of an increasing proportion of pension fund trustees moving to customised benchmarks tailored to their individual scheme dynamics, the trend towards specialist international managers has also increased dramatically with close to 38% of respondents indicating that over 60% of their pension assets are now managed by international money managers. We expect this trend will continue to filter its way to the smaller/medium end of the market with clear implications for the local investment management community. The most popular area of alternative investments are tactical asset allocation strategies and emerging market equities.
Lack of knowledge in the area is believed by 66% of respondents to be the major barrier to increasing their allocation to alternative assets. We believe that much needs to be done in this area in terms of education for trustees and sponsors as well as the provision of ‘institutional friendly' products for pension funds. Having said this, the number of these types of funds is increasing all the time and are now accessible to smaller and more medium sized pension funds.
Going forward, the main areas of focus for trustees and plan sponsors are getting investment manager selection right and the setting of investment strategy.
While both of these areas received equal prominence in our survey, we would contend that the setting of investment strategy is a far more important exercise. Historically, investment managers (specialist or otherwise) have accounted for only 10% of the actual return and risk level achieved by pension plans with the other 90% attributed to getting right the basic allocation to equities, bonds property etc. While better investment management will help the cause, the impact is likely to be much less significant than restructuring the investment strategy of the fund.
In conclusion we believe this survey to be very representative of the Irish pension and investment landscape and reflects broadly held views and trends. It analyses trustees' and plan sponsors' attitudes to the investment risks and objectives that are driving their investment decisions; their attitudes to investment managers and also their willingness to invest in alternative asset classes.
In an ever evolving investment and pensions world, we believe it is incumbent on all trustees and plan sponsors to continuously assess the appropriateness of their investment objectives, their tolerances to risk and the structures by which their respective investment managers manage their assets. Ultimately this continuous reassessment is simply about good pensions governance - protecting a pool of assets for the future benefit of employees. We hope these survey results help to encourage this reassessment and indeed add to the ongoing pensions debate.
Tom Geraghty is head of Mercer Investment Consulting in Dublin