The Pensions Regulator (TPR) has published new research on leverage and liquidity to better understand the potential risks for defined benefit (DB) pensions.
TPR’s analysis will also help inform the Bank of England’s Financial Stability Report. It initially found that many schemes are well-diversified and actively monitoring the risks in their portfolios that may arise in relation to leverage and liquidity.
However, it also shows that some schemes are pursuing more risky investment strategies that seek extra returns, which could be damaging in the event of adverse economic shocks.
TPR said DB pension investment arrangements evolve over time and new approaches to managing risk and implementing investment strategies develop. Recently there has been a significant increase in the number of schemes developing strategies based on matching pension scheme cashflows, often with significant reliance on building portfolios of assets with contractual cashflows and/or where an illiquidity premium is expected to be captured.
It said that the development of these strategies is not wholly unexpected, particularly as schemes are becoming increasingly cashflow negative as they mature, these strategies have been developing within a relatively benign investment environment where interest rates are close to historic lows and credit conditions have generally been accommodative.
Fred Berry, TPR’s head of investment consultancy, said: “In a low yield environment, the search for yield has led to some schemes seeking riskier and more illiquid investments to earn their targeted return. We believe that some of these strategies introduce additional risks which may not be adequately rewarded, and which may amplify market impacts in the event of adverse shocks.
"We also believe that some of the longer term illiquid investments may not adequately allow for the risks that climate change may introduce.”
Berry also said that TPR will analyse the survey responses in more detail and consider how they can use the findings to help trustees to improve their risk management practices further.