European survey of pension fund asset allocation

European pension funds are paying increasing attention to implementing effective governance structures in order to navigate the growing complexity of the investment landscape, according to a new survey by Mercer's investment consulting business.

The survey of over 1,100 European pension funds with assets of EURO538 billion found that, to ensure investment objectives are met and market opportunities seized, more Trustees are establishing investment committees, conducting formal interim investment strategy reviews and putting resource into managing investment arrangements in a more dynamic way.

Results also show Trustees are now more comfortable with delegating short-term investment strategy and implementation decisions to asset managers and consultants. This allows them to adapt more easily to market-related factors affecting their investment strategy.

Nick Sykes, European director of investment consulting at Mercer, commented: "As the world of investment becomes increasingly complex and asset strategies and risk management tools become more sophisticated, ensuring the investment strategy is set and monitored appropriately is even more vital to scheme success.

"The potential advantage of establishing solid governance structures is becoming apparent to pension schemes in terms of improved performance. Many see the benefit of an implemented consulting approach where some aspects of strategy design and implementation, requiring expert knowledge and resource, are taken off their hands by an external provider."

Diversification

Risk management continues to be a theme for investors across Europe, with a broader range of risk exposures being taken to ensure the benefits of diversification are secured. Although current pension fund exposure to alternative asset classes remains relatively modest, most schemes are expected to increase allocations in 2008.

In the UK, global tactical asset allocation (GTAA), funds of hedge funds and active currency management are the most commonly-used alternative asset classes. Together with non-domestic property, these are expected to experience increased popularity throughout 2008. In contrast, allocations to UK property will continue to decline.

Andrew Kirton, head of Mercer's investment consulting business in Europe, commented: "This year's survey comes at a pivotal moment potentially after an extended period of benign economic and market conditions. Arguably the robustness of existing governance and investment exposures could be tested significantly in the period ahead.

"It is encouraging to note that risk management is high up many investors' agendas, together with an awareness that market turbulence, whilst demanding that risk exposures be understood and controlled, should also lead to investment opportunities as the year progresses. Dynamism and focus will be required to grasp these opportunities."

Equities

UK funds continue to see a reduction in exposure to equities, at 58 percent, compared with 61 percent last year and 68 percent in 2003. In contrast, the European region as a whole is seeing a shift towards equities, with an average allocation of 50 percent in 2008, up from 42 percent at the start of 2007. The UK position is driven by maturity and risk management considerations. The movement elsewhere in the opposite direction may well reflect realisation that equities, on many measures, appear to have value, in comparison with bonds.

Funds in the UK continue to increase their non-UK equity market exposure and, as a result, UK equities continue to fall, now at 51 percent of total equities compared to 53 percent last year. In France, Germany and Spain, funds still favour Eurozone equities, however Swiss and Dutch funds have an equal split between local and global equities.

Mr Sykes commented: "The switch away from UK equities is greater than it first appears, as strong equity market performance since the market lows of 2003 would have resulted in an increase in allocation."

Liability-driven investment strategies

Liability-driven investment strategies are becoming more accessible in the market-place and the survey results show an almost doubling of schemes expected to have such strategies in place by the end of the 2008. Mr Kirton said: "Investing relative to the liabilities, whereby the amount and nature of risk taken on is assessed relative to the liabilities, has much to commend it, at least in terms of a frame of reference for decision-making, where solvency and/or maturity considerations are important in markets such as the Netherlands, UK and Ireland."