Survey: Inflation Tops List of Worries for UK Schemes

(April 4, 2011) — According to a Pension Fund Barometer published in Financial News, UK pension schemes face three major challenges: inflation, regulation, and the threat of a double-dip recession.

1) Inflation

The survey of 64 European pension schemes with more than $426 billion (€300 billion) of assets showed that inflation is the most pressing concern for investors, with 92% of respondents citing it as a slight concern or a serious worry, according to Financial News.

Regarding the threat of higher inflation, Cynthia Steer, managing director of investment strategy at Russell Investments, told aiCIO earlier this year that institutional investors are increasingly pressured to understand the implications of inflation and deflation. In order to do this, she explained, they must examine their portfolios within different risk parameters, looking at their sensitivity to inflation and deflation.

In the US, funds have taken steps to actively combat the threat of rising inflation. Following a nearly year-long review, the investment committee at the $220 billion California Public Employees’ Retirement System (CalPERS), the biggest US public pension fund, approved a new risk-based asset allocation in December. Seeking to guard itself from extreme market risks and rising inflation, the CalPERS board increased the asset allocation of public equity, infrastructure and forest land, inflation-linked bonds and Treasuries. Meanwhile, it lowered its allocation to fixed-income and commodities. The allocation for private equity and real estate remained unchanged. “We learned in the financial crisis and the past recession that a liquidity crunch or inflation can have a significant impact on portfolio performance in ways that many investors didn’t anticipate,” said Rob Feckner, CalPERS Board President, in a news release on the fund’s website.

2) Heightened Regulation

Additionally, the Pension Fund Barometer survey showed that 85% of respondents reported that increasing regulation was a top concern. The regulation largely centered on indications by the European Union that it might impose strict insurance standards, known as Solvency II, on pension schemes.

“I tend to feel that regulation is a fact of life; what we have to push for is good regulation rather than bad,” Mike Weston, chief investment officer at the Daily Mail & General Trust pension scheme, told Financial News.

Pension providers have said the financial impact of the proposed changes is difficult to predict. However, a study commissioned late last year by actuarial consultants Punter Southall indicated that a ‘solvency buffer’ could significantly increase the price tag of running a typical final salary scheme by 90%. Joanne Segars, chief executive of the National Association of Pension Funds (NAPF), warned that the potential rise in costs would force many employers to reconsider whether they could still afford to run DB schemes. “While a Solvency II type system of regulation is appropriate for insurance, the Commission needs to recognize that occupational pensions operate in a very different way,” Segars said in a statement, noting that it would be unfair for pension providers to be put in the same risk category as insurance companies since unlike insurance firms, retirement funds typically face predictable liabilities.

3) Double-Dip Recession

Lastly, the risk of a double-dip recession was ranked as a top concern among 80% of those surveyed. The report indicated that crisis in the Middle East and Japan have led to heightened volatility, highlighting the reality of uncertain environments and the threat of a recession.

However, from an investment perspective, consultants have expressed the belief that the volatility in Japan and the Middle East will not have a noticeable, long-term impact on most institutional investors’ portfolios, urging investors to view regional turbulence within context.