It is also good to learn that UK pension schemes, many of which had an 80 per cent weighting in equities at the height of the dotcom boom in 1999, have since been reducing that exposure and slowly diversifying their assets.
Mercer canvassed over 1100 European pension funds with €538bn of assets. UK pension funds, which accounted for just over 70 per cent of total assets surveyed, now have an average equity allocation of 58 per cent, down from 61 per cent last year and 68 per cent in 2003. The proportion of equities invested in the UK stock market also continues to fall and stands at 51 per cent today compared to 57 per cent two years ago. As total equity exposure falls, average bond allocations have grown to 38 per cent.
According to the report, 20 per cent of all schemes, on an asset-weighted basis, have already adopted some form of liability-driven investment strategy and this figure is forecast to double within the next year.
As more assets have been invested outside the UK, the use of currency hedging has increased with more than one-quarter of pension funds surveyed now hedging part of their currency risk. The average proportion of currency risk hedged is over 60 per cent.
In contrast with the UK, the average equity allocation of European pension funds has risen from 40 per cent at the start of 2006 to 50 per cent in 2008, possibly because a higher proportion of schemes are open to new members and future accruals than in the UK. The exposure of European funds to bonds and other assets fell during 2007.
The report says that as the use of fund-specific benchmarks grows, savvy Dutch investors are giving their asset managers more freedom to use credit default swaps, emerging market debt, high yield bonds and interest rate swaps.
Active currency management is reported to be one of the most popular alternative asset classes, along with hedge funds and global tactical asset allocation. While there was no significant increase in allocation to these asset classes in 2007, many of the UK funds surveyed said they planned to increase their exposure during 2008.
It is remarkable to find that despite the hype and marketing drive of the last six years, less than 6 per cent of UK schemes surveyed were invested in funds of hedge funds, while a mere 2 per cent were subscribing to single hedge strategies. And less than 2 per cent of respondents had bought into private equity funds of funds, while just over 1 per cent were invested in individual private equity funds.
Demand for commodities, infrastructure, high yield, emerging market debt and non-domestic property was even lower, at less than 1 per cent of UK schemes surveyed. The low take-up by UK pension funds of alternative investments, particularly hedge funds and private equity, is at odds with their perennial expressions of growing interest in these assets.
In contrast, commodities, hedge funds and non-domestic property are, says Mercer, among the most popular alternative asset classes outside the UK, with over 13 per cent of European funds having some allocation to commodities. The proportion of European schemes subscribing to hedge funds is almost 50 per cent greater than within the UK.
The survey found that pension funds are looking to set up new governance structures to enable them to better monitor their investment strategy relative to predefined objectives. The proportion of funds with designated investment committees and procedures for managing their investment strategies between formal reviews is projected to increase this year.
Where pension funds conduct interim strategy monitoring, the most popular means of adapting asset allocation is either opportunistic - where the funds alter their investment strategy based on market conditions, or objective-related - where the fulfilment of a fund-specific measure triggers a move from one asset class to another. A minority of funds adopt a mechanistic approach, whereby the fund will move from the current benchmark to a target benchmark by phasing in the move over time via a series of interim benchmarks.
Where fiduciary duties are delegated away from the trustee body, the most popular delegate is the investment sub-committee.
Mercer observes that pension funds are happy to delegate certain aspects of strategy management, especially short-term investment strategy and implementation, to asset managers. Funds are said to be comfortable delegating manager monitoring to their investment consultants who are also being asked to take responsibility for investment strategy implementation.
Henry Smith, editor
henry.smith@ft.com
