Pension funds continue to move out of equities and into fixed income in order to deal with the breakdown of the fundamental relationship between asset returns and inflation, UBS Global Asset Management said in its Pension Fund Indicators report.

Under normal market conditions, the risk-free rate is expected to exceed the prevailing rate of inflation by a modest amount. The current market environment of negative real rates means that it is extremely difficult for investors to exceed an inflation plus target, regardless of their asset allocation, UBS said.

To solve this issue, pension funds continue to move out of equities, in particular UK equities, and into fixed income assets. While pension funds’ exposure to overseas equities is higher than that to UK equities, it has nonetheless fallen from a peak of 32 per cent in 2005-06 to 25 per cent, a level last seen in 2001. Interest in alternative investments is increasing, making up 9 per cent of the average pension fund’s portfolio last year, up from one per cent a decade ago.

UBS Global Asset Management head of UK and Ireland Ian Barnes said: “In a low interest rate environment, the need for income is also key. As DB schemes increasingly mature, and as annuity rates remain challenging for those, more and more people are looking at drawdown rather than annuitisation.

“As a consequence, the demand for income generation from pension schemes is increasing. What is required is a more fundamental investment programme engineered to generate income in a more appropriate way. The market has few such products at the moment and we encourage the industry to concentrate on developing solutions for this problem, else a bad situation will be made worse.”

The report estimated UK pension assets at around £1,600-2,000bn and found that pension assets in most OECD countries have climbed back above the level managed at the end of 2007, although some countries have not completely recovered from the 2008 losses, with Ireland, Spain and Portugal among them.

Other findings included that during the last 10 years, global DC assets have grown at a rate of 7.9 per cent a year, while global DB assets have grown at a rate of 4.6 per cent. It suggested a split of 61/39 for DB/DC assets in the UK at the end of 2011, not including personal and stakeholder assets but including insurance administered vehicles. If the latter were excluded as well the proportion of DC assets would fall to 25 per cent, for occupational self-administered pension assets.

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