An evolution occurred in pension fund portfolios following the financial crisis as allocations shifted away from equities and into less volatile areas – and the changes are not over yet. According to Towers Watson, equity allocations by UK pension funds fell from 65 per cent to 50 per cent between 2003 and 2013. And last year a Mercer survey of more than 1,200 European pension funds showed that “plans in the UK had made a meaningful shift out of equities over the last 12 months, with the average equity allocation falling from 43 per cent to 39 per cent. The comparable figure was 68 per cent in 2003”.
While UK schemes have traditionally had larger equities allocations compared with European counterparts, Mercer said in terms of equity exposure they were now behind Ireland, Belgium and Sweden. In spite of a fall in pension funds’ allocations to equities over the past decade, they retain a firm place within portfolios. But as well as falling as a percentage of portfolios, a serious shift has also happened in terms of the geographical scope of those remaining equities. For some time now, portfolios have been increasingly global.
The move towards global equities was a long time coming, though. In the past domestic equities were central to portfolios, and historically UK pensions invested in a mix of UK equities and bonds. Data quoted in the National Association of Pension Funds report Trends in Defined Benefit Asset Allocation, published in July 2013, showed that half a century ago pension fund portfolios were split with on average 47 per cent in UK equities and 51 per cent in UK fixed income.
The NAPF report explains: “The allocation to UK equities hovered around 50 per cent until as recently as 2000 although the UK fixed income allocation fell consistently throughout the 60s, 70s and 80s, dropping as low as 7 per cent in 1993”. Initially, funds diversified into real estate, and later into overseas assets, “almost entirely comprised of overseas equities”.
Today, pension funds are more likely to be weighted significantly more in overseas equities than in UK equities. The NAPF report shows that average DB funds’ overseas equities allocation is more than twice that of UK equities allocations. But geographical allocations continue to evolve, says T. Rowe Price International vice president and head of UK and Ireland institutional business Tim Bird.
“The move away from UK equity to global equity is still ongoing in the pension industry,” he says. “We saw a lot of headlines about the death of equities in 2009, but these proved to be false dawns. Equities have remained fairly static, but are still large allocations for pension funds. People are beginning to remember that equities can do a lot for them.”
It may have taken time for UK pensions to build confidence in global equities, but the evolution is now firmly underway. “Historically, we have seen this move from UK equities to global equities as pension funds become more comfortable taking on currency exposure and keen to build less concentrated portfolios,” says Aon Hewitt head of equity fund manager research Phil True.
Naturally, a large part of the move towards global equities has come from pension funds’ requirement for increased growth in the face of funding issues. “There is a requirement to get exposure to extra risk to help pension funds close any deficit. They need extra equity risk to get those returns,” says True.
T. Rowe Price’s Bird agrees. “Let’s not forget,” he says, “there are still many pension funds with negative funding gaps and they need growth. They are obliged to think about the long term.” And as those longevity risks and funding deficits place increasing pressures, funds are heading further afield to find the growth they need.
Just how they access global equities varies to a degree, depending in many ways on the size of a scheme. For the largest schemes, it may be possible to access a well-diversified portfolio by working with managers specialising in different geographical regions, says True. “Regional managers may be appropriate for very large schemes but they would have to do searches on each manager for each region. For some of the very big schemes it may work, but it would be costly and time consuming, and would not work for smaller and medium sized schemes.”
For the majority, then, access to global markets comes through global equities funds investing in stocks across the world. But the term ‘global equities’ covers, literally, a whole world of possibilities, and for many trustees gaining an understanding of just what this may entail is important. “There is a lot of debate over what exactly global equity means,” says Bird. “For us, we are talking about investing across the world. We hold Nigerian banks, banks in Asia - it’s not just the developed world. For us it really means fishing in a global pond. It is a really broad remit.”
Different funds use different indices, such as the FTSE All World and the MSCI All Country World Index (ACWI), and the countries included can vary. T. Rowe Price’s approach means that companies the world over are viable options, whether in developed countries or in emerging markets. This brings huge scope of choice, but, Bird says it does not mean dipping in and out of markets and companies on a short-term basis. “There is more flexibility but it is not macro play,” he says. “It is very much a bottom-up process. We are investing in companies and holding for a long time.”
This unconstrained approach allows managers to hunt far and wide and select from a truly global palette, which can lead to a broad spread and a valuable level of diversity within. “We are believers in having a diversified and unconstrained approach,” Bird says. “It is very important in managing risk.”
However, direct access to equities in emerging markets, within a broader global fund, does not suit every pension fund. Not because funds want to avoid emerging markets per se, but because they would rather keep their allocations to this area apart.
“A lot of pension funds are very committed to emerging markets, and if anything they are looking to increase their allocations,” says JLT senior investment consultant Kieran Harkin. “But often these will be built as a separate exposure, an extension of a global equities portfolio.”
True agrees: “There is an element of talking to trustees about what they want to achieve,” he says. “Many trustees are interested in a second emerging markets allocation.”
There is also a desire to divide up risk levels, explains Invesco Perpetual institutional sales team’s Rob Barrett. “There is a tendency towards low volatility, and pension funds will often have a low type return, mid and high octane, so rather than just having global equities, they have a range of risk levels. There is a degree of slicing and dicing, and working with a sort of matrix with more managers,” he explains. “Sophistication has changes in trustee boards. We see they have been cutting back on equity exposure. They are more aware of risk, and see it as a sort of necessary evil [in order to achieve returns].”
There is also debate around the management styles behind global equities funds, with some suggesting that costs of active approaches can sometimes outweigh benefits. Passive management, which relies on tracking indices, is traditionally a lower cost approach and, arguably, can be advantageous in markets such as the US. The additional costs of going with an actively managed fund is, of course, up for discussion, since reducing costs is a vital part of improving returns. But as True says: “There will always be a focus on cost but that has ratcheted up recently. Passive is still an option for some, although for us, first and foremost we would choose an active, unconstrained approach.”
Sandra Haurant is a freelance journalist