Pension funds should look to diversify their growth portfolios away from equities in the current market environment, according to Cambridge Associates.

According to the firm, pension funds can protect themselves from a potential collapse of the stock market by turning their attention to other assets. Traditionally, most pension funds invest in equities to achieve growth, but with global stock market valuations so stretched, prospects over the near term seem bleaker, the firm said.

Alternative assets such as private credit, private equity, and real assets, may slightly outperform a traditional growth portfolio on a risk-adjusted basis, Cambridge Associates said.

Its head of the European pensions practice, Alex Koriath, said: “UK pension schemes have dramatically improved their financial position over the last decade but if they want to defend that progress they may have to examine how their growth portfolios are set up to withstand the future market environment.

“Generating excess returns relative to liabilities is important even for better-funded schemes as investment returns can help protect against unexpected increases to liabilities due to demographic changes and to cover ongoing expenses.”

While a review of the return-generating elements of the growth portfolio would be particularly well-timed, Cambridge Associates explained that pension schemes should also consider how they are making best use of fixed income investments to generate income.

Low bond yields and scheme demographics means the focus is shifting to alternative credit investments in the search for yield. A growing proportion of schemes are becoming cash flow negative as contributions reduce, which places more importance on income-generating assets or become forced sellers of growth assets.

With traditional investments such as gilts and investment-grade bonds at such low yields, trustees should look to alternative credit markets such as high yield, private credit, royalties and long-term leasing.

In addition, Cambridge Associates said trustees should not ignore the role of hedge funds in their portfolios.

However, Koriath warned: “Trustees should be extremely selective when investing in hedge funds as so many charge high fees, employ excessive leverage and provide little transparency. At this point in the cycle, trustees need to reassess their growth portfolio to ensure their investments are structured to help meet their long-term objectives.”

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