Assets of top 50 U.K. pension funds jump 15.5%

The 50 largest pension funds in the U.K. had about £603.2 billion ($1.03 trillion) in assets as of June 30, an increase of 15.5% compared with the same date in 2012, according to Pensions & Investments' survey of the funds.

The top 10 alone accounted for just shy of 45% of the total, at £269.4 billion, about the same from 2012's figures. The top 10 funds' assets increased 12.8% during the two years.

There also was movement at the top, with the Universities Superannuation Scheme, London, moving into first place with £42.6 billion. It swapped places with the BT Pension Scheme, also based in London, at £41.2 billion of assets.

Three bank-sponsored funds rounded out the top five, holding the same rank as in the previous survey: Lloyds TSB Group PLC pension plans, Bristol, with about £34 billion of assets; Royal Bank of Scotland, Edinburgh, with £26.8 billion; and Barclays Bank PLC, London, with about £24.6 billion.

Asset allocation among the top 50 plans changed, reflecting companies' moves to reduce risk. The weighted average allocation to equities dropped to 36.2%, from 38.4% in 2012. Fixed-income exposure increased to a weighted average of 40.2%, up slightly from 40%, while alternatives were up to 10% from 7.4%. Real estate made a gain in weighted allocation overall for the top 50 funds, by 0.1 percentage points to 6.4%

“The broad derisking trend continues,” said Tapan Datta, partner and head of asset allocation at Aon Hewitt, London. “That is the nature of the defined benefit (funds) that we have.”

Mr. Datta said a combination of years of regulation and rising longevity of participants have helped to drive this trend.

However, he said the derisking trend slowed early this year. While strong performance in growth securities bolstered asset values — the FTSE All-Share index returned 13.4% for the year ended June 30 — gilt yields fell at the start of the year. Funding levels at all U.K. corporate defined benefit pension funds fell to 87% in the year ended June 30, from 91% as of June 30, 2013, according to a monthly index by JLT Employee Benefits, part of Jardine Lloyd Thompson Group PLC.

The lack of change is even more pronounced over a longer period of time. “Funding levels should tie in with the growth in markets. That is the most fascinating thing: Over the last five years, the FTSE 350 funding level is steady. We have had phenomenal growth in markets, yet funding levels have not budged because gilts have almost perfectly offset the gains from growth assets,” said Mr. Datta.

Despite much weaker fixed-income returns for the year ended June 30, compared to two years prior, allocations to the asset class continued to increase. The Barclays Sterling Aggregate index returned 3.8% for the year ended June 30, 2014, compared with 14.4% for the year ended June 30, 2012.

“There is a bar-belling occurring in fixed income,” said Mr. Datta. “Fixed income is held on both sides: growth and matching.” While there is recognition that corporate spreads are “pretty thin,” he said, exposure continues to increase because pension funds continue their move toward liability-driven investing. “(But) with yields low, the search for yield has intensified (within fixed income.) The search for high yield is a key driver on the growth side of the fixed-income story. There is much more looking further afield for quasi-credit type exposures.”

Roger Gray, chief investment officer at USS, said the fund views fixed income in this dual-purpose way. “We see fixed income as a spectrum of opportunity, which we blend according to our perception of risk/return,” he said.

The firm's fixed-income allocation increased to 26.9%, from 17.4%, in the two years.

“Ignoring LDI and fixed-interest holdings that pre-funded now-completed infrastructure investments, we have since June 2012 sold equities to fund a 3% allocation to emerging market debt and to increase the allocation to developed government bonds by 4 (percentage points) and to corporate bonds by 1.5 (percentage points),” said Mr. Gray. “Our emerging market debt exposure is at the return-seeking but not extreme end of fixed income.”

Non-traditional asset classes made gains in the weighted average allocation stakes. Alternatives took 10% of the weighted average allocation in the top 50 funds' portfolios, up from 7.4% in 2012. Within the top 10 funds, alternatives took an even higher weighting, making up 13.1% of those funds, up from 9% in 2012. Equities appeared to suffer at alternatives' popularity, taking a 32.1% portion of the average top 10 portfolio, compared with 36.8% in the 2012 report.

Hedge funds, said Mr. Datta, have increased in popularity despite a general perception of lower returns. “People have genuine hedging considerations here: equity and bond markets have run up high, so there is implied market view (in these decisions),” said Mr. Datta. He said a greater range of attractive strategy mixes are now possible through strategy selection, and there is more advice available to pension fund executives on how to build a diversified hedge funds portfolio.

“On one level (increased allocation to hedge funds) is a surprise — we see hedge funds underperforming, and to some extent that is true. But you are not picking the average hedge fund: you are picking the top quartile. (So) it makes sense not to look at the average hedge fund as the dispersion (between the best and worst performing) is so great,” said Mr. Datta. The HFRX Global Hedge Fund index gained 5.3% in the year ended June 30, compared with 24.1% for the MSCI All-Country World Investible Markets index.

Commodities have continued to have a difficult year, with the S&P GSCI commodity index down 28.3% year-to-date through Dec. 17. However, Mr. Datta believes this asset class might be set for a revival of sorts. “I suspect that over the next 12 months, we might see some reversal of that: some money might come back in, but as yet we haven't seen a flow reversal back into commodities.”

Private equity also has been popular, said Mr. Datta, with more segmentation within the asset class. The Cambridge Associates Global Buyout & Growth Equity index returned 23.1% for the year ended June 30.

USS, the U.K.'s largest fund, has 18.6% of the portfolio allocated to alternatives. The highest allocation to alternatives was the £21.1 billion Railways Pension Scheme, London, with 28.3% invested in the asset class.

Mr. Gray said the alternatives program has grown “moderately” in the past two years, compared with when he joined five years ago and the fund had an allocation of just 8%. As of June 30, the fund had about 3.2% invested in hedge funds, “which has ebbed and flowed a bit over time.” It had a 10.5% allocation to private equity in various forms, and a 5.5% allocation to infrastructure and timber. That, he said, has grown by more than two percentage points in the two years.

Executives at the fund have embarked on several large transactions in the past 18 months, with a £150 million equity investment in a port terminal in Virginia, a 10% stake in Heathrow Airport Holdings and investment in several toll roads and rail-link assets, through its infrastructure allocation.

“What we are looking to achieve in those transactions is reliable, long-term, inflation-linked cash flows which provide a useful counterpart to the inflation linked, long-term liabilities of the pension fund.”