Are pension funds holding unnecessary amounts of liquidity and, if so, how can they be persuaded to increase risk and delve into more illiquid strategies? Lynn Strongin Dodds takes a look.
“Purely investing in liquid assets can still lead to a scheme being a forced seller if they need to raise cash to pay pensions at a time of market stress.”
Mike Walsh, LGIM
At the end of last year, a study by Cambridge Associates urged pension funds to pare down their liquidity holdings and bolster their illiquidity stakes. This is not a new clarion call but one that has grown louder as funding gaps have widened particularly after the Brexit vote and the ensuing plunge in bond yields.
Figures from PriceWaterhouseCoopers, which has been tracking deficits since 2012, make for sober reading. It showed that the country’s roughly 6,000 defined benefit (DB) schemes’ collective funding chasm swelled by around £90bn to £560bn in 2016. By contrast, the comparable figure for the S&P 1500 was around $408bn, up only $4bn from 2015 levels.
Taking a longer time horizon, other studies reveal that the average DB funding level has dropped from 109% in 2007 to 84% in 2015. The FTSE 350 camp have been particularly hard hit with around 50% of their DB schemes tottering or actually in cashflow negative territory, according to a report by Hymans Robertson. Drilling down, this translates into schemes having shelled out £20bn more to pensions than received in contributions two years ago and this is set to rise to £100bn by 2030.
Proponents of liability driven investment (LDI) could also face higher cash calls under the European Market Infrastructure Regulation which calls for derivatives – a key plank in these strategies – to be collaterised. Fund managers are expected to turn to securities lending and repo to create l iquidity, but they may have more breathing space if the European Commission gets its way. Last year, the regulator proposed extending the exemption for pensions funds which was due to expire in August.
