Asset allocation trends across the UK and Europe
Joanne Holden, Global Head of Investment Research
We believe that asset allocation is one of the most important decisions an investor makes. A thorough assessment of risks is critical to constructing a portfolio that will seek to meet your objectives whilst managing risks and opportunities that may arise. The COVID-19 pandemic has introduced additional challenges as investors wrestled heightened market volatility and the economic impact of the pandemic throughout 2020. Even one year later, uncertainty over the future path of the pandemic and whether vaccine-driven reopening can be sustained remains.
Many countries have made significant strides along the journey toward economic recovery as vaccine roll-out across the UK and Europe has mitigated the impact of COVID-19 which led most countries to fully reopen; however, regardless of the circumstances in your country, it is always a good time to review your allocations in light in light of shifting economic and market backdrops. Mercer’s European Asset Allocation Insights 2021, a series of four reports, provides a comprehensive overview of investment strategy across the UK and European defined benefits and defined contribution pension industry, and identifies emerging trends in the behaviour of c. 850 institutional investors across 11 countries, reflecting total assets of c. €1 trillion.
Defined benefit trends
UK defined benefit de-risking
Defined contribution trends
The biggest concerns for investors this year were COVID-19 remaining an obstacle for the hoped-for full reopening and a stock market correction. Around 20% of survey investors rated them as main concerns.
Allocation to alternatives are now almost at par with equities for Europe as a whole and higher than for equities in some countries (for instance the UK).
Just over half of surveyed investors plan to review investment strategy, manager mandates or plan governance. However, more than a third do not plan any changes to their plan’s governance as a direct consequence of last year’s events.
Bond yields touched new record lows during 2020. More investors are now considering alternatives to government bonds for their income producing part of their portfolio.
Almost 80% of plans are cash flow negative. This is expected to rise to just under 90% in five years and almost 100% within the next ten years. Most plans are still disinvesting assets to fund cash flow but there has been an increase in plans requiring income generating assets to distribute as opposed to reinvest that income.
Covenants of many plans may have deteriorated with the COVID-19 fallout. Plans with covenants described as “weak” or “tending to weak” only have a marginally smaller allocation of 13% to equities, compared to 17% for plans with a covenant described as “strong” or “tending to strong"
The direction of travel for most plans is still to gradually de-risk from growth assets into liability matching assets as and when opportunities arise and increase hedge ratios opportunistically. This helps prepare the plan for the endgame which is in most cases to move to a self-sufficient position and eventually buy out benefits with an insurer.
The majority of UK pension plans use liability-driven investment strategies (LDI) to hedge their liability risk with >80% of plans between £50 million and £2.5bn indicating that they have an LDI framework in place. This proportion is much lower for the largest and smallest plans.
The average DC default fund allocated almost half of their assets to equities which is to be expected for funds that are early in their accumulation phase. Most funds are heavily concentrated in developed market equities but have at least a small allocation to emerging markets.
For most countries, alternatives amount to the second largest allocation for DC default funds after equities with almost one third of assets allocated to alternatives.
Bond portfolios are almost equally split between government bonds and credit on aggregate but for some countries there is a heavy government bond bias.
The vast majority of investors have firmly embedded ESG considerations in their investment process, a trend that has strengthened further during the COVID‑19 crisis.
When asked to rate the importance of environmental, social and governance considerations, respondents in all countries except for Ireland responded that the environment was considered the most important area of focus.
Climate change and governance are established areas of fiduciary scrutiny. A significant minority of respondents are looking to further expand the scope of their sustainability activities to social issues, other environmental issues (for example biodiversity) and diversity, equity and inclusion.
Stewardship is mainly thought of in relationship to equity mandates, however, increasingly it is applied across the board, to both fixed income and alternatives portfolios.
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