UK corporate pensions must be prepared to take investment risk in order to address the sector’s estimated £249.4 billion aggregate deficit, according to Redington.
“By taking more rewarded risks on the asset side and hedging some of the liability-side risks, you can achieve something better.”The consultant’s analysis of funding data from several sources indicated that future returns will provide less than half of the cash needed to close this shortfall.
In the 10 years ending 2015, pension funds have slashed their equity exposures from 61% to 35%, Redington found. This helped reduce the “funding level at risk” measurement from 19% to 10%.
But pensions still may be taking “unnecessary risk” on the liability side, wrote Dan Mikulskis, co-head of asset-liability management and investment strategy, and Pete Drewienkiewicz, head of manager research. “By taking more rewarded risks on the asset side and hedging some of the liability-side risks, you can achieve something better.”
UK pensions’ current aggregate portfolio allocation has an expected return of “around cash plus 1.7%—roughly 4% in absolute terms over a 20-year time horizon,” the pair added in their report, “The Great De-Risking, Or Is It?”.
“We estimate that in aggregate UK pension schemes on average need returns of cash plus 2.4% to cash plus 2.9% to be fully funded by 2030,” the pair said, “depending on whether contributions are maintained at today’s levels or reduced.”
To hit this level, pensions not only need to put more emphasis on liability management and hedging, but also be willing to take more investment risk, Mikulskis and Drewienkiewicz argued.
As well as liability-driven investing strategies to reduce funding ratio fluctuations, the pair urged investors to explore “equity market neutral or diversifying strategies that run at material levels of volatility of 10% plus.”
High yields, illiquidity premiums, and “dynamic” strategies with flexible asset allocations were all positive attributes investors should seek out, they added.
Related: De-risking by Conference Call & 2015 Liability-Driven Investment Survey