London, 4 December 2023 – Despite the improved funding positions that many UK defined benefit (DB) pension schemes now find themselves in, 35% are still undecided on their endgame objective, according to the latest findings from Russell Investments’ UK Defined Benefit Market Insights Study.

In its third iteration, Russell Investments’ biannual series surveys senior stakeholders in the UK DB market to understand their current views and priorities.

For the majority who have decided on their long-term target, buyout (38%) remains the most popular option, while runoff or low dependency strategies (21%) are also being considered. Just 5% of schemes have changed this target in light of funding improvements over the past year, with much more focus being on the timeframe to reach it. 30% of pension schemes are working towards endgame within a shorter timeframe but are seeing more challenges in their ability to adjust asset allocations and access buyout solutions.

The research finds that almost a quarter of schemes now expect to reach endgame on a 1-3 year view. As a result, de-risking towards endgame has increased significantly in importance for pension schemes over the last twelve months. 56% of respondents identify this as an investment priority – a rise of 11% compared to Russell Investments’ first DB Market Study in autumn/winter 2022.

Improving or maintaining funding levels (56%) and managing market risk (53%) remain key priorities. An increased number of schemes also identify the importance of reducing pressure on their sponsors (30%) and addressing leverage and collateral issues (27%). Larger schemes (those with more than £1 billion of assets) appear more focused on leverage and collateral (37%), as well as on increasing liquidity (31%) and improving diversification (29%) than their smaller peers.

Pension scheme decision-makers also identify a number of potential challenges ahead with a fifth of survey respondents highlighting the ability to access buyout providers as a major cause for concern.

Key findings from the Russell Investments’ The Changing Ecosystem of Defined Benefit Pensions – Volume 3 include:

• Concerns over inflation and central bank policies have receded significantly over the last six months. For the first time in this research series, a minority (48%) of respondents identify this as a key concern, a fall of 26% compared to twelve months ago. Concerns over recession have also fallen notably, declining by 29% over the last twelve months. Just one-quarter of respondents now identify this as a key concern, suggesting a greater sense of optimism towards the UK economy.

• While investment priorities remain largely consistent across the survey universe, a higher proportion of larger schemes (those with more than £1 billion of assets) identify improving or maintaining funding levels (63% vs. 49% of smaller schemes), de-risking towards endgame (62% vs. 53%) and managing market risk (60% vs. 47%) as key focuses. In contrast, a higher proportion of smaller schemes identify cashflow generation (27% vs. 19% of larger schemes) and increasing levels of return (24% vs. 19%) as investment priorities.
• Decision-makers expect to decrease exposure to property (30%), developed market equities (20%) and private equity (16%) over the next six months, whilst allocations to government bonds (35%) and investment grade credit (31%) are anticipated to increase over the same period. However, respondents highlighted potential concerns about their ability to reduce exposure to illiquid assets, noting the significant demands being placed on secondary markets.
• While improving ESG remains a key consideration for half of all schemes, their decision-makers are increasingly cognisant of the difficulties they face in taking meaningful action on environmental issues. Just over a quarter (26%) of respondents indicate that they are ‘unlikely’ or ‘very unlikely’ to increase their focus on climate change in the next twelve months, compared to just 7% this time last year. This potentially suggests climate change has become a lower priority in the context of other focuses for some schemes.

The Russell Investments study surveyed 107 UK DB pension schemes between September and October 2023, with respondents (including scheme chief executives, chief investment officers, trustees and pensions managers) representing a total of over £250 billion of assets under management. Around half of respondents were responsible for more than £1 billion of assets. Russell Investments also conducted interviews with 12 leading independent trustees to provide additional context to the survey findings.

Commenting on the findings, Simon Partridge, Head of UK Fiduciary Management at Russell Investments, said:

“DB schemes are having to rapidly accelerate their efforts and planning as significant improvements to funding levels over the last twelve months put many much closer to endgame than they would have previously anticipated. This does, however, bring challenges, with legitimate questions being raised over the capacity of providers to satisfy the increased demand for buyout solutions. Competition will be at a premium and schemes seeking to go down the buyout route will need to work in conjunction with their advisers over the coming months to satisfy the requirements of insurers.”

Allocations to fixed income increase as schemes continue to focus on de-risking

The push towards endgame and focus on de-risking is being reflected in asset allocation decisions, with a notable rise in decision-makers’ plans to increase exposure to fixed income assets. 35% of respondents expect to increase allocations to government bonds (a rise of 10% compared to the same period in 2022), with 31% anticipating increases to investment grade credit exposures. Private credit and infrastructure also remain popular with asset owners (particularly smaller DB schemes), with 14% and 12% respectively expecting to increase allocations. In contrast, significant divestment is expected from property (30%) and developed market equities (20%) as schemes continue to de-risk.

Worries over inflation and recession diminish

Having been a key concern over the last twelve months, worries about inflation have reduced significantly (by 26% compared to autumn/winter 2022), with less than half (48%) of respondents identifying this as a focus area in the next six months. Worries over the potential for recession have also decreased (falling by 29% compared to the same time last year), as have concerns over market selloffs and volatility (down 6%). However, despite these improved circumstances, a majority of respondents plan to continue to maintain (68%) or increase (23%) their hedge ratios in the next two years, which indicates some caution remains, along with a continuing desire for schemes to ‘bank’ the gains of the last twelve months.

Schemes face greater limitations on ESG action

Improving sustainability and ESG remains an important consideration for pension schemes, with half of respondents seeing this as a priority. Climate change continues to be a key focus, with the majority of respondents (58%) indicating they are ‘likely’ or ‘very likely’ to increase their focus on this area in the next twelve months. However, the proportion of schemes ‘unlikely’ or ‘very unlikely’ to increase their focus on climate change has grown by 19% in the last 12 months, now representing just over a quarter (26%) of respondents.

Pension schemes identify challenges in how to practically approach ESG amidst the acceleration towards endgame. The move away from certain assets (such as equities) typically considered more suitable for ESG-related action in favour of fixed income is creating limitations on what schemes feel is achievable from an ESG standpoint. Accelerated timelines towards endgame are also impacting the length of time schemes can hold certain assets, potentially limiting the extent to which these can therefore have any meaningful long-term impact.

Partridge concluded:

“While positions for DB schemes have undoubtedly improved over the last twelve months, with many in much closer proximity to endgame, it has in parallel created a new set of complex challenges for decision-makers. As the pensions landscape continues to shift significantly, outsourcing will have a critical role to play in helping schemes navigate operational, asset allocation and regulatory considerations that will all need to be addressed if schemes are to meet their long-term goals.”

More information on the Russell Investments’ The Changing Ecosystem of Defined Benefit Pensions – Vol 3 is available here.

Stephanie Ramos, Russell Investments
sramos@russellinvestments.com
+44 (0) 207 02 46 446

The Russell Investments UK Defined Benefit Market Insights is based on the responses of 107 UK defined benefit schemes between September and October 2023. Those participating in the study are responsible for over £250 billion of assets under management in total, with almost half representing schemes with over £1 billion of assets. Respondents included scheme chief executives, CIOs, professional, company- and member-nominated trustees and pension managers. Responses were collected via an online survey conducted by SurveyMonkey, with support from the Pensions and Lifetime Savings Association (PLSA).

To supplement our insights, Russell Investments also undertook detailed interviews with a focus group of twelve senior independent trustees to assess their views on a range of key topics. We would like to thank those individuals interviewed for their time and insights.

Russell Investments is a global investment solutions firm providing a wide range of services to institutional investors, financial intermediaries and individual investors. The firm has $298 billion (or £234 billion or €273 billion) in assets under management (as of 30/06/2023) for clients in 30 countries. Headquartered in Seattle, Washington, Russell Investments has 17 offices in major financial centers, including New York, London, Paris, Toronto, Tokyo and Shanghai.

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