UK pensions no longer lead Europe in their allocations to equities following another year of cutting exposures in a focus on managing funding volatility, according to Mercer.

The consultant’s European Asset Allocation Survey found UK funds’ equity allocation dropping from 43 per cent to 39 per cent over 2012, despite market rallies. A decade ago, allocations stood at 68 per cent.

Irish, Belgian and Swedish schemes are now all more heavily reliant on shares. However, across Europe schemes’ focus on funding volatility is growing. The proportion of schemes allocating to liability hedging or liability driven investment mandates rose to more than a quarter (26 per cent) over the year, up from 15 per cent. Nearly half – and about three quarters in the UK – also now allocate to alternatives.

Mercer Investments UK head Pat Race said: “Against a backdrop of ultra-loose monetary policy, negative real interest rates and a range of unsolved economic issues, pension plans are faced with the challenge of generating positive real returns, while reducing funding level volatility. In response, investors are expanding their investment tool-kit, making their strategy more dynamic, and are introducing scenario and stress test analysis into the risk management process.”

Among the asset classes seeing growth in the last year were non-traditional
property, including infrastructure, timberland and agriculture, and emerging market debt and high yield debt, as well as senior loans and private debt. Almost 20 per cent of funds now allocate to diversified growth funds (DGFs).

According to Mercer’s investments business European director of consulting Nick Sykes, the trend away from equities and increased use of alternatives is likely to continue.

He said: “Pension schemes across Europe, but particularly in the UK, remain on a path towards a lower-risk investment strategy. However, the approach to reducing risk will not simply mean increases to government bond allocations and simple swap strategies. Instead, increasing interest in assets that offer a relatively stable and inflation-sensitive income stream is anticipated, such as ground lease property and infrastructure. A broader approach to fixed income investing, to include buy and maintain corporate bond strategies and multi-asset credit funds, is also on the horizon. Sophisticated LDI strategies are also proving essential for providing a greater degree of flexibility and responsiveness to changing market conditions.”

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