Saturday, 22 July 2017

    Schemes risk crystallising losses in market corrections

    An increasing number of schemes are turning cashflow negative. Their de-risking plans and investment strategies need to take account of that

    More than half (55%) of the UK’s defined benefit (DB) schemes are now cashflow negative, according to new research from consultants Mercer. 

    Cashflow negative schemes do not achieve enough income from their investments and contributions to cover the cost of members’ pensions. That means they may need to sell assets in order to meet those liabilities. 

    deficit index

    Mercer’s 2017 European Asset Allocation Survey show an increase of 13% in the number of cashflow negative schemes over the last 12 months (42% in 2016). By 2027, 85% of respondents whose schemes are not currently cashflow negative expect to be in that situation.

    Phil Edwards, global director of strategic research at Mercer, described being cashflow negative as a “natural life stage of a mature DB pension scheme”.  However, he cautioned that less than 40% of respondents currently have a formal de-risking strategy, which “leaves a large body of schemes with no clear plan in place”, making them more susceptible to market fluctuations and the risk of crystallising losses if they are forced to sell assets to meet liabilities.

    The report also showed that schemes are investing more in alternative assets. This is part of a steady upward trend over the last five years, from 14% in Mercer’s 2013 figures, to 22% in the 2017 report. Schemes have reduced their exposure to equities accordingly, with the average equity allocation now 29%, compared to 39% in 2013. Bonds account for the remaining 51% of assets in the 2017 allocation.

    Higher returns in exchange for lower liquidity – and in some cases a regular income stream from the assets – is a key reason for the shift towards alternatives. However, for cashflow negative schemes investing in illiquid assets needs careful consideration, said Edwards. “Trustees of cashflow negative schemes need to be sure that, in the event of a large market correction, liquid assets are available to meet cashflow and collateral needs.”

    “We would encourage all schemes – large and small – to use scenario planning and stress-test analysis to understand how a market correction might impact their financial health.”

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