Pension funds and charities demand alternatives exposure

Extreme volatility in the world’s stockmarkets has bolstered demand for alternative investments in pension schemes offering diversification, smoother returns and more peace of mind for both employers and scheme members.  

Although the dramatic rebound since March has restored colour to the cheeks of some sickly-looking pension schemes, poor long-term returns and high volatility have left others questioning the traditional basket of long-only equities, bonds, gilts and property.

Total assets in defined contribution (DC) schemes, as measured by Aon’s DC tracker, slumped an incredible 60%, from £550 billion at the beginning of 2007 to £344 billion in March. Meanwhile the average ABI UK All Companies fund – a favourite of default schemes – dropped 45% from June 2007 to the low in March.

But by the end of September, assets had swelled again to £507 billion, spurred on by the bounce in the markets, and the average All Companies fund had shot up 49% – but by no means enough to cover most savers’ losses.

This extreme volatility capped a ‘lost decade’ for equities, which were the worst performing asset class between 1998 and 2008, delivering average annual returns of -0.15%, according to Barclays Equity Gilt study.

Perhaps it is unsurprising that traditional approaches to pensions fund management are being challenged. According to Adam Walker, a scheme actuary and investment consultant from Barnett Waddingham, this includes an almost slavish adherence to benchmark asset allocation.

He says: ‘The traditional benchmark approach took funds over a cliff. Managers held on to equities because they held what the benchmark told them to hold. Now everyone is complaining about these falls and wanting to give managers the leeway to do something more intelligent.’

Marek Siwicki, head of consultant relationships at Gartmore, says while there is still faith in equities over the long term, the effect of volatility on pension scheme assets is more visible because of stricter accounting rules and this is driving demand for alternatives.

He says: ‘Short-term volatility is becoming much more of an issue and pension investors are looking for diversification. There is also a lot less focus among pension investors on getting massive returns. They are more focused on keeping volatility under control and on smaller, steady returns.’

Siwicki believes another reason for the increased use of alternatives is the departure from the traditional trustee model, which has often been the root of a conservative approach to investment. ‘There is a growing trend to give work out to consultants,’ he says. ‘A knock-on effect of this is that consultants will put together more sophisticated solutions. They will build more diversified pension funds, and use more absolute return and alternatives.’