- Bonds remain the dominant asset class for Irish pension schemes, despite persistent low yields
- Allocations to equities rise after strong year of stock market performance
- Allocations to alternative assets by Irish pension schemes remain behind the European average
- More work to do on the impact of climate change on investments
Bonds remain the most significant asset class for Irish pension schemes, despite persistent ultra-low bond yields. This is according to Mercer’s 2017 European Asset Allocation Survey, which shows that Irish pension schemes now have an average allocation of 48% to bonds, remaining broadly the same as the 49% allocation last year.
The survey of over 1,200 institutional investors across 13 European countries, reflecting total assets of around €1.1 trillion, also showed that for Ireland the average allocations to equities have risen modestly over the year from 36% to 40%, reflecting the strong rally in equity markets. The survey shows that Irish schemes have been slower to move into alternative assets than their European counterparts with a 10% allocation compared to the European average of 13%.
Commenting on the report, Paul Kenny, Partner, Mercer advised: “Irish pension scheme trustees are in a difficult position with holding bond assets. On one hand, very low yields mean future returns on bonds are likely to be low, even negative. On the other hand, the Pensions Authority is clear that bonds, which are deemed low-risk assets for defined benefit pension schemes, remain the most appropriate asset for these schemes, even given ultra-low yields”. Mr. Kenny added: “The challenge for trustees is getting the balance right: allocating enough bonds to manage risk and adhere to regulatory pressures without jeopardizing the long-term viability of the pension scheme”.
In relation to the increased allocation to equities seen in the survey, Mr. Kenny noted: “Equities have performed well since the recovery from the financial crisis started in March 2009. They have had a particularly strong last 12 months following the Trump and Macron victories in the U.S. and France. However, pension scheme trustees should keep in mind that equity market corrections can be unexpected and severe. Rebalancing overweight allocations to equities, implementing risk management strategies that protect against equity corrections and diversifying into alternative assets remain more important today than ever”.
Alternative assets, including corporate loans, infrastructure and hedge fund strategies, have been increasing in importance over recent years, but allocations still lag behind equities and bonds. In relation to Irish pension schemes’ allocations to these types of assets, Mr. Kenny advised: “We would like to see more progress in this area. Although trustees need to be mindful of unnecessary complexity and cost, assets that offer a better balance of risk and return should be explored”.
Separately, Mercer’s Report identified a gradual increase in the number of European pension schemes factoring environmental, social and corporate governance (ESG) issues into their investment processes. Financial materiality was the main driver behind this trend, cited by 28% of respondents; this was followed by reputational risk, cited by 20%. Mr. Kenny commented: “The increase in asset owners citing financial materiality as the driver behind considering ESG risks is a positive development – asset owners simply cannot afford to dismiss ESG risks as non-financial”.
However, despite NASA stating that April 2017 was the second hottest since records began in 1880 (with 2016 the hottest), Mercer’s report found that only 5% of the 1,241 pensions schemes surveyed had considered the investment risks posed by climate change. Mr. Kenny commented: “The report findings highlight the need for the industry as a whole to do more. The pace of response to this enormous issue is slow and all investors and advisors need to more formally consider the long-term risks and opportunities presented by climate change”.
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