European pension fund executives are keeping a close watch on inflation as they seek to better manage risk within their investment portfolios, according to Mercer’s annual European Asset Allocation Survey, released Tuesday.
Concerns about rising inflation led about 18% of the respondents to add exposure to inflation-linked bonds. About 5% are increasing inflation-sensitive assets such as commodities, while 3% said they plan to add inflation swaps.
“The outlook for investment strategy over the coming year is very much one of risk reduction — whether explicitly, through an increase in the use of ‘matching’ assets such as government and corporate bonds, or implicitly, through increased diversification,” according to Mercer’s report of the survey, which questioned executives of 1,100 pension funds throughout Europe with aggregate assets of €550 billion ($817 billion).
About 20% of those surveyed said they’re planning to increase exposure to domestic government bonds and/or alternative assets. Emerging markets debt proved attractive, with 22% of the respondents in Europe ex-U.K. planning to increase exposure to the asset class in 2011 compared with 9% the previous year. In the U.K., about 12% plan to add emerging markets debt vs. 6% of respondents in 2010.
In the U.K., distressed debt also gained popularity, with about 7% saying they’re planning to add exposure compared with 2% who said the same a year ago. Outside of the U.K., commodities, infrastructure and timberland are proving more attractive. In 2011, 14% of the respondents said they’re increasing exposure to commodities vs. about 9% a year ago. About 16% are adding exposure to infrastructure and 16% to timberland, compared with 7% and 5%, respectively, the previous year.
“The use of inflation-sensitive assets, such as infrastructure, timberland and agriculture, are much more common in those countries that do not have a well-developed inflation-linked bond market,” according to the survey report.
The shift from domestic equities continues to grow, particularly in the U.K., with the average U.K. pension fund allocating about 21% of assets to domestic equities compared with 25% last year and 28% in 2009. Overall, U.K. pension funds have about 47% of total assets in equities, down from 50% a year ago and 54% in 2009, according to the survey.
Ireland’s pension funds also drastically reduced equities, averaging 50% in 2011 vs. 59% a year ago. Swiss pension funds averaged about 30% of total assets this year compared with 35% the previous year. In the Netherlands, however, the average pension fund had a 26% exposure to equities, an increase of three percentage points from 2010.
The equity exodus is likely to continue, with 23% of European ex-U.K. funds and 35% of U.K. funds planning further reductions to domestic equities in the coming year, according to the survey.