See Inside: U.K. Pension Funds and Money Managers
Top 50 U.K. pension plans hold more than $800 billion
Asset allocations vary greatly among funds
By Thao Hua | January 21, 2013
The 50 largest U.K. pension funds had about £513 billion ($800 billion) in assets, with the top 10 alone accounting for about 45% of the total as of June 30, according to Pensions & Investments' inaugural survey of the funds.
The BT Pension Scheme topped the list with £38.5 billion, followed by the £33.8 billion Universities Superannuation Scheme, both based in London. Lloyds TSB Group PLC pension plans, which had about £29 billion in total assets, rounded out the top three. Of the top 10, three others were pension funds sponsored by financial institutions: Royal Bank of Scotland, Barclays Bank PLC and HSBC Holdings Bank PLC.
Regarding asset allocation trends, equity exposure among the top 50 pension funds averaged 38%, which is lower than the 43% average for all U.K. pension funds, according to a comparison of P&I's survey against data from Mercer. The weighted average allocation to fixed income is about 40%, slightly lower than the broader U.K. pension fund average of 42%. The top 50 pension funds also had a higher weighted average to property at 6%, compared with the overall U.K. pension fund average of 3%.
In the combined categories of alternatives and “cash and other,” the top 50 also outpaced the overall market with about a 15% allocation compared to the 12% average of all U.K. pension funds. (The categories were combined in this article to compare pension funds that separated their alternatives investments — which included hedge funds, private equity and other alternatives — with those who lumped similar types of alternatives investments into the "cash and other' bin. In addition, the move was made to better compare the survey data with broader pension industry figures provided by investment consultants.)
Even more assets
The top 10 pension funds held even more assets in the combined alternatives and “cash and other” categories, with a weighted average of 19% of the total portfolio at the expense of both fixed income and equities, according to the survey, which was conducted in October and November with additional data researched from secondary sources. Exposure to property was also slightly higher at the top 10 pension funds, which averaged a 7% allocation to the asset class.
About 40% of the top 50 pension funds reported a detailed breakdown of their alternatives portfolio. Among those, the weighted average allocation to private equity was 2.8% among the top 50 funds and 3.9% among the top 10 funds. In comparison, the weighted average allocation to hedge funds stood at 1% for the top 50 funds and 0.9% for the top 10 funds.
“Generally, pension funds are derisking and reducing allocations to risk assets,” said Tapan Datta, London-based principal and global head of asset allocation at Aon Hewitt. “The funding level is pretty critical in the long-term progression of pension funds in the U.K.”
A lot of pension funds are closed, some to new entrants and others to new accruals, said Alasdair Macdonald, senior investment consultant and head of the U.K. investment strategy team at Towers Watson & Co., Reigate, England. Others are still open, so larger pension funds are continuing to diverge “in terms of where they are in their journey to wind up their schemes,” Mr. Macdonald said “If they have no more new liabilities, for example, then it's all about derisking.”
In March 2012, a U.K. government decision to nationalize the £28 billion Royal Mail Pension Plan, London, was finalized. As a result, the fund was not included in the list of the top 50 pension funds. Overall asset allocation decisions can be simplified into a two-stage approach, with the first being the split between the bond portfolio — an indication of how much risk a fund is willing to take — and the return-seeking portfolio, Mr. Macdonald said. The next dimension is the complexity of the investment strategy, which depends on the market opportunities compared against the internal resources available to manage those investments.
Larger pension funds are in a better position to make a quicker shift into the more complex alternative asset classes, partly because of a more developed governance structure, more internal resources and investment capabilities, consultants said.
At USS, for example, a 2009 decision to increase the target allocation to alternatives to 21% from 9.5% has resulted in an expansion of the alternatives investment team to 25 from 14, including a new infrastructure team of three investment managers with a supporting team of analysts. Within alternatives, USS now has an 18.5% exposure to alternatives, including 11% invested in private equity, 3% exposure to infrastructure and the remainder in absolute-return strategies. USS' target allocation for alternatives includes an 8% exposure to private equity, 7% in infrastructure and timber, and 6% in absolute-return strategies.
“It takes time to build up the resources to manage a full alternatives program, and it then requires a degree of patience in accessing the right long-term investments,” said Roger Gray, chief investment officer of USS and CEO of USS Investment Management Ltd., which is owned by the fund and was incorporated last year.
“USS' strategic asset allocation reflects the scheme's positive cash flow, long-term liabilities and strong covenant,” Mr. Gray added. “This permits (the fund) to have more of a return-seeking policy and a degree of illiquid investments.”
Even among the top three funds, the asset allocation strategies differ markedly. For example, while USS has more than 50% invested in traditional equities, both BT and Lloyds hold less than 40% of their total assets in equities, according to the survey. In terms of traditional fixed income, USS has less than 20% of its total assets invested in the asset class, while both BT and Lloyds have about 40% allocated, according to the survey.
In general, corporate pension funds tend to hold more traditional fixed income, partly because of adopting liability-driven investing strategies. The £4.6 billion Boots Pension Scheme, Nottingham, England, which is among the pioneers of LDI in the U.K., invested about 85% of its total assets in fixed income. Others with a fixed-income exposure of 80% or higher as of June 30 include: Rolls-Royce PLC pension schemes, London, which had combined assets of about £9.6 billion; the £8.6 billion Imperial Chemical Industries Ltd. Pension Fund, London; Prudential PLC pension schemes, London, which had combined assets of about £7.2 billion; RSA Group PLC pension schemes, London, which had total assets of about £5.5 billion; and Invensys PLC pension schemes, London, which had combined assets of about £4.3 billion.
However not all corporate pension funds are reducing risk. Among the most prominent example is the £15.6 billion BP Pension Scheme, London. The pension fund has a 61% exposure to listed equities, 17% allocation to fixed income and 7% invested in property. About 11% is invested in private equity, and there's no dedicated target allocation to hedge funds.
“The investment policy is designed to reflect the maturity of the fund and levels of risk that the sponsor can sustain,” said Sally Bridgeland, CEO of BP Pension Trustees Ltd., London. “With a large sponsor and with liabilities which are less mature than most, the fund is still a long-term investor and the risk tolerance can be higher.”
The dispersion in asset allocation trends among the U.K.'s 50 largest pension funds is widening, consultants said. The allocation to equities, for example, ranged from less than 5% of total assets for Invensys to 83% of the portfolio at The Northern Ireland Local Government Officers' Superannuation Committee, Belfast, which had about £4 billion in assets as of June 30, according to the survey.
“There's a much wider range of investment strategies adopted by pension schemes, which reflects the different circumstances of the schemes,” said Phil Edwards, principal within Mercer's investment consulting business based in Bristol, England.
“Investors have started to use a slightly different lens to think about asset allocation strategies,” Mr. Edwards added. Beyond asset classes, risk factors and return drivers are playing a larger role in asset allocation. Despite having gone “a long way in terms of diversification, most schemes still find that the biggest driver of returns is equity risk.”
The range of pension fund allocations to traditional fixed income is similarly as wide as it is in equities, with the £5.1 billion Merseyside Pension Fund, Liverpool, and the Northern Ireland Local Government Officers' fund each holding less than 10% of their total assets in traditional fixed income. The Rolls-Royce pension scheme has an 88.5% exposure to traditional fixed income.
Overall market movements will likely drive the balance between the allocation to bonds and return-seeking assets in the next one to three years, consultants said. “If equity markets rise, that will allow pension schemes to reduce equity exposures — and reduce risk. If bond yields rise, that will likely increase the level of interest-rate hedging undertaken by schemes,” Mr. Edwards said.
Allocations to alternatives were also mixed among the top 50 funds. While many had almost no exposure in alternatives, a few targeted more than 20% of the total portfolio toward hedge funds, private equity and other alternatives.
Even within one organization, pension fund asset allocation can differ. At the £4.1 billion London Pensions Fund Authority, for example, total assets are divided in two — the £2.6 billion active portfolio, which is comparatively a return-seeking portfolio dominated by equities and alternatives, and the £1.5 billion pensioner portfolio, which largely follows a liability-driven investing strategy.
“We've got quite a lot of bonds in our LDI strategy, and over the next few months, we'll be looking at whether that's the most appropriate form of collateral to support the pensioner fund,” said Mike Taylor, CEO of the LPFA based in London. “The prospects on the bond market are not positive, so we will review that strategy.”
Since the pensioner portfolio is underfunded, underperformance of the bonds would further exacerbate the shortfall. “We've considered a whole range of options, including changing the asset allocation. But so far, we're not convinced that any changes (in the asset allocation) would be the right thing to do, given the risk profile of that fund,” Mr. Taylor said.
Another major concern for LPFA fund executives is the decline in membership. The number of active members has dropped 9% in the past 2 1/2 years, which translates into a reduction in contributions and lower future cash flows into the funds.
No major changes to the overall asset allocation strategy are planned now. In the longer term, however, fund executives might consider reducing the fund's illiquid holdings, increasing allocation to assets “which better match our cash flows” such as infrastructure and reduce equities exposure, Mr. Taylor said.
As pension funds shift the return-seeking portion of the portfolio away from equities into alternatives, they need additional skills and resources to manage the increasingly complex investments, consultants said. “Some alternatives really stretch governance and liquidity budgets,” Mr. Datta of Aon Hewitt added. “That has been another key reason why some pension funds have embraced alternatives and others haven't.”
This article originally appeared in the January 21, 2013 print issue as, "Top 50 U.K. plans hold more than $800 billion".