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Funds turn to non-cash assets

Use of non-cash assets to fund pension schemes is no longer the preserve of the FTSE 100, finds Richard Crump

27 Sep 2012

By Richard Crump

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PENSION FUND ALLOCATIONS to alternative assets are on the up as investors, rattled by the volatility created by the eurozone crisis, continue to turn their backs on the equity markets.

According to research by Mercer, an increasingly broad range of alternative asset classes are being considered by pension plans, with 50% of schemes now holding an allocation to alternatives.

Schemes in traditionally equity-heavy markets, such as the UK, have experienced the largest falls in equity allocations, down 4% on 2011.

“In their quest to continue to control volatility without sacrificing long-term returns, investors have turned their attention to alternative asset classes,” comments Nick Sykes, European director of consulting at Mercer’s investment business. “In addition to their attractiveness compared to low-yielding bonds, alternative asset classes offer appealing diversification characteristics.”

In the UK, the most popular alternative asset classes were diversified growth funds, macro hedge funds, also known as GTAA strategies, and funds of hedge funds.

Alternatives

While Mercer’s report looks solely at pension funds with assets of more than €650bn (£525bn), SMEs are now starting to look at their own alternatives to pension funding.

The threat of continued low gilt yields, coupled with lower arrangement costs, has prompted pension schemes with liabilities of less than £100m to look towards non-cash assets to fund their defined benefit liabilities.

Asset-backed funding has typically been the domain of the FTSE 100. However, FTSE 350 and SME deals are anticipated by the end of the year as businesses look at creative strategies in which assets such as real estate, brand royalties, intellectual property or stock can be a viable alternatives.

“The cost of arranging asset-backed funding has previously been prohibitive for some organisations but - faced with diverting more cash into their scheme as a result of low gilt yields - this option is now firmly back on the table,” says Kenneth Donaldson, director of actuarial services for Capita Hartshead.

“Low gilt yields are a double whammy for pension schemes as they impact both future funding calculations and investment returns. Schemes will have to engage with new ways of meeting funding targets to prevent diverting more cash from normal business activities like investing for growth or paying dividends.

“Asset valuation, structure of arrangements, due diligence and employer covenant strength are all potential deal breakers so special attention to these areas is required to keep negotiations open and member benefits secure.”

Sponsors will also be assessing their derisking strategies alongside their funding position. While market conditions for arrangements such as buyouts are currently less than optimal, early preparation will allow sponsors to get the right kind of deal when things improve. ■

 

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