Current de-risking strategies are in danger of introducing significant financial risk for pension schemes, a new report by investment adviser Cambridge Associates claims. Low interest rates mean the 'glide path' that sees schemes reallocate to fixed income assets as funding levels improve will leave many dependent on much higher sponsor contributions in future.

“In the current environment of fixed income overvaluation and historically low interest rates, the commonly accepted approach to constructing a glide path is likely to result in a significant decline in expected return,” said David Druley, managing director and head of the global pension practice at Cambridge Associates. “Therefore, the likelihood of a sponsor needing to make higher contributions jumps dramatically and presents a formidable financial risk."

Current glide paths are too 'mechanical, relying solely on allocations to fixed income to reduce risk, without reference to returns, the report argues.

"The traditional glide path neglects the objective of maximising return at each targeted level of risk," Druley said.

The paper, Pension De-Risking in a Low-Rate Environment– A Better Solution, argues for a 'holistic' alternative, controlling not only the amount allocated to growth assets as funding levels improve, but also the risk within the growth assets. Greater use of active strategies emphasising manager skill and alternative beta, with allocations to distressed credit, hedge funds, and private investments, could cut volatility in the funding levels and generate superior returns, it argues.

“The merits of this approach are accentuated within the current environment of extremely low interest rates,” Druley said. “Carefully moving some growth assets into strategies that derive a significant amount of returns via alpha, or manager value-add, can potentially allow a pension scheme to keep more assets in the growth portfolio, operate at the same risk level as the more simple glide paths and generate higher expected returns.”

Share Story: