State Street’s Haines and Patel look to the state of selection driving long term savings

Raymond Haines, head of EMEA Strategy & Research, State Street Global Advisors and Chirag Patel, head of State Street Associates EMEA, State Street Corporation, have looked at the drivers of asset selection in Europe’s changing long term savings market.

Funding gaps pose ever greater challenges to defined benefit (DB) schemes across Europe as they battle to combat funding deficits and the low-yield environment. But while taking measures to address potential funding gaps, pension scheme sponsors must also heed evolving standards for managing risk against returns, and successfully clear higher regulatory hurdles.

Closing funding gaps at a time when low returns have become expected is, in fact, the number one challenge cited in research commissioned by State Street and carried out by the Economist Intelligence Unit among 150 pension schemes across Europe.* Closures of DB schemes are expected to gather momentum over the next five years, with 75 per cent of respondents predicting that “persistent funding challenges” will accelerate DB schemes’ demise and accelerate the transition to defined contribution (DC) schemes.

From an investment perspective, some 60 per cent of DB respondents suggest they will look at increasing their exposure to alternative strategies over the next three years, with a similar number likely to hone in on emerging markets. This trend is particularly strong in areas such as the Netherlands and Nordics, although less pronounced in countries such as the UK and Germany. Encouragingly, however, there is a degree of optimism that the funding challenge can be overcome: 62 per cent say they think funding levels will improve over the next five years.


chiragpatel-lge (Raymond Haines & Chirag Patel pictured)

A central question in the debate over plan design is the extent to which pension scheme sponsors should consider further hedging their risk by shifting from traditional to “new” asset classes in light of recent developments such as the Eurozone crisis. That question is not so much about new asset classes, but more about taking different approaches to existing asset classes, including thinking about strategies that are more risk aware, while also taking into account the risks of the past few years. For example, this means potentially moving away from market cap weightings and benchmark indices into areas that actually reflect the risks of the underlying credit.

It is not so much that new asset classes have become attractive as a result of the Eurozone crisis as schemes have learnt that they should have greater asset diversification. While a shift toward alternative assets is evident, opinions vary on which asset classes are most likely to support pension schemes in their core objectives. The importance of taking a holistic approach with a long-term investment horizon rules out focusing on one particular asset class, although a case should be made for tactical allocations away from the long-term strategic asset allocations that have historically been held by most pension plans.

Yet even as they seek to diversify, funds find themselves impeded on the regulatory front. One of the greatest challenges is that diversification is currently very expensive from a regulatory perspective. Liquidity constraints are also a challenge. The regulatory structure is making it more difficult for pension funds to achieve their underlying objectives.

In any event, the question of assessing the risks and dangers of so-called “new asset classes” remains vital. The benefits that in-vogue asset classes, such as infrastructure, may offer in principle are more difficult to achieve in practice. These asset classes also call for greater governance and management resources, as in the case of bank debt, for example. Although, the internal expertise to thoroughly understand what such exposures entail may be lacking, industry expertise does exist to help investors understand precisely what these allocations mean, for example, by tracking how capital requirements governing private equity may affect a fund’s liquidity risk.

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