It’s been an eventful start to the year for the European pensions industry.
U.K. gilt yields soared to record levels during the first working week of 2025, while the second brought the closure of game-changing government consultations for DC and local authority pension schemes. Across the North Sea, three Dutch pension funds shifted nearly 200,000 members and €12 billion ($13 billion) in AUM from DB to DC arrangements under the Netherlands’ new pension system
The pace of change is unlikely to slow any time soon, with the forthcoming implementation of trade tariffs on China and Europe by U.S. President Donald Trump, which will potentially dampen emerging countries’ growth as a result.
Political uncertainty in major European countries such as Germany and France, coupled with growing nationalism in Europe, is also expected to make it increasingly challenging to coordinate pan-European policies regarding economic reforms, migration and European defense.
Overall, the evolving pension fund landscape in Europe underscores the importance of adaptive investment strategies, sustainable practices and innovative governance models. Given the current backdrop, there are four key themes we are encouraging pension funds to keep front of mind.
ESG headwinds
Sustainable investments are anticipated to face further headwinds in 2025, with the Trump administration driving a negative sentiment towards environmental, social and governance-related investments in the U.S. To a degree this is already starting to spill over into European markets, meaning global asset managers may need to navigate different sustainability ambitions of their U.S. and European clients.
Sustainable investments, as defined by Sustainable Finance Disclosure Regulation standards as Article 9 funds (i.e., products which have a sustainable objective and therefore target specific sustainability outcomes alongside financial returns) are still niche in the world of pension funds. That said, many funds no longer accept Article 6 investment funds — those which only assess and address sustainability risks, leaving Article 8 funds as the dominant and preferred ones.
Biodiversity is increasingly being viewed as the most important environmental theme, more than climate change, and one that also has great influence on social development topics. European pension funds are increasingly investigating ways of implementing biodiversity in their portfolios.
Emerging markets allocations
Against this backdrop, it makes sense for pension funds in Europe to contemplate their strategic allocations towards emerging markets, including equities and debt denominated in local and hard currencies.
However, investments in emerging markets might face challenges given the potential for slower global growth, trade wars between the U.S. and other countries, increasing geopolitical stress and ambitious sustainability agendas.
Local currency emerging market debt has not performed well over the last decade, and emerging markets dollar-denominated debt must compete with the U.S. high-yield bond market. What’s more, excluding countries like China and Saudi Arabia from an emerging markets universe on sustainability grounds leaves limited investment options. This also holds true for listed companies in emerging markets, apart from Taiwan and South Korea. An allocation to these emerging market equities alongside developed markets could be made via an all-country world index mandate rather than as a separate allocation, while excluding certain countries on sustainability grounds.
U.S. equity market still attractive
Historically, the U.S. market has often acted as a perceived safe haven for capital in times of uncertainty, something that could well continue in 2025. The dollar is already on the rise compared to the euro — and hedging dollar assets will likely become more costly next year.
U.S. companies’ profitability is likely to underpin current equity market levels. Large-cap technology companies might be best equipped to weather an international trade storm, given strong momentum in artificial intelligence and U.S. companies’ leadership position in technology more broadly. It is unlikely that this will change in the near future, positioning U.S. companies well to benefit and given the lower valuation of the domestic companies making the U.S. equity market still attractive. The risk is of course that the implementation of high trade tariffs on foreign goods will hit the exports of U.S. companies in 2025.
Balancing risk and return
The search for income-generating assets may lead pension funds to consider hih-yield bonds as an alternative to traditional fixed-income securities. Particularly in countries like Germany, where the current interest rate environment and demographic challenges — including an aging population and a shrinking workforce (and consequently declining pension contributions) — have pension funds pursuing long-term income-generating instruments such as cash flow-driven investing.
But while the potential for higher yields is attractive, pension investors will need to remain vigilant about credit fundamentals, liquidity considerations and the impact of economic cycles on high-yield bond performance. Furthermore, ongoing monitoring of default rates and issuer-specific factors will be essential for pension funds evaluating U.S. high-yield bond opportunities as spreads are historically tight.
We expect pension investors’ appetite for emerging markets equities and government bonds, as well as U.S. high-yield bonds, to be influenced by a balance of return potential, risk considerations and diversification objectives in 2025. Pension funds will likely seek to strike a balance between pursuing investment opportunities that offer attractive yields and managing the associated risks effectively, aligning their investment decisions with long-term portfolio objectives and risk management principles. Equities seem set to deliver more favorable returns in 2025 compared to bonds.
From a U.K. perspective, a key theme continues to be the trend towards buy-ins and buy-outs where a proportion — or all — of the pension fund’s assets are sold to insurance companies who then manage the assets. The ongoing focus on risk management and liability-driven investment strategies, which aim to secure funding surpluses and fulfill long-term pension obligations, will continue, as will the higher allocation to credit assets to match insurer pricing. Potential regulatory changes around the use of the surplus in 2025 will most certainly be something to watch.
By staying abreast of these four themes, pension funds across Europe can position themselves to navigate the complexities of the investment environment in 2025 and beyond.
Martin Sanders is head of pension investments at AXA Investment Managers. He is based in the Netherlands. This content represents the views of the author. It was submitted and edited under Pensions & Investments guidelines but is not a product of P&I’s editorial team.
