Higher interest rates are driving pension schemes towards fixed income endgame solutions, with most set to continue moving towards lower-risk, lower-return seeking portfolios, analysis from the Pensions Management Institute (PMI) and Schroders Solutions has found.

The report found that almost two-thirds (64 per cent) of respondents have benefited from increased funding levels due to the shift to a higher interest rate environment over the past 12 months, with 35 per cent experiencing a rise of over 5 per cent.

In response to these funding improvements, the vast majority (83 per cent) of schemes are now defining an endgame strategy, with a 53/47 split between buyout and low dependency.

The size of the scheme strongly influenced this decision, according to the research, which showed that larger schemes (over £500m) favoured low dependency whilst those under £500m favoured buyout.

A "noteworthy" 78 per cent of respondents are also adjusting their return requirements, with the vast majority (83 per cent) now looking to reduce their targets.

Of those looking to make asset allocation shifts over the next 12 months, some 38 per cent were targeting increased corporate bond allocations and 29 per cent greater liability-driven investment (LDI) exposures.

In addition to this, 38 per cent and 40 per cent of investors were looking to reduce their equity and illiquid allocations respectively, with this trend more pronounced among those targeting a buyout outcome.

Liquidity was also a growing consideration more broadly, as almost half (49 per cent) of the schemes surveyed said liquidity needs will be an increasingly important priority in decision-making during 2024.

Recent DB funding improvements have also prompted schemes to take a closer look at their surplus options, with just over one in five (22 per cent) considering returning this to the employer.

A further 10 per cent were considering a cross subsidy with DC arrangements, while 15 per cent were considering augmenting member benefits.

These findings come shortly after the launch of the government's latest DB consultation, which is looking at plans designed to help make DB surplus extraction easier, to improve member outcomes and increase investment in the UK's productive finance assets.

However, despite the government's recent push to encourage greater investment in UK growth, the vast majority (86 per cent) of schemes felt that it is not the role of DB schemes to finance the UK economy.

There were also broader issues on the horizon, as nearly three quarters (74 per cent) of respondents admitted they are concerned about the impact of UK politics and policy on the long-term sustainability of pension scheme arrangements.

Commenting on the findings, Pensions and Management Institute (PMI) director of policy and external affairs, Tim Middleton, said: “This survey provides a very clear assessment of the UK’s DB sector in 2024.

"The most prominent picture is of the number of schemes which have become very mature and which also have sufficient funding to consider the most appropriate endgame solution.

"For mature DB schemes, this is seen through the reported attraction to corporate bonds and a corresponding reduction in exposure to equities. Trustees clearly see liquidity as important in their schemes’ stage of the glide path and this is reflected in reduced exposure to illiquid assets.

“It is also interesting to note how trustees’ thinking concerning endgame solutions has evolved in recent years. Until very recently, bulk annuitisation was seen as the only viable option.

"While 45 per cent of the surveyed schemes are considering this, 40 per cent are considering the alternative of run-off. Many smaller schemes may also be considering the new option of DB consolidation.”

Adding to this, Schroders head of UK business development, institutional, Ronan O’Riordan, said: “These results indicate that schemes will likely continue moving towards lower-risk, lower-return seeking portfolios.

"Allocations to fixed income could offer schemes several benefits including providing predictable income streams, stabilising returns and offering lower volatility compared with equities.

"Fixed income can also be structured to deliver regular cashflows which can be aligned to liquidity demands, further enhancing their suitability for these schemes.

“The shift towards LDI and this emphasis on liquidity could also indicate a trend towards reducing leverage and increasing collateral coverage. This would improve schemes’ liquidity and resilience to market shocks, a key lesson from the 2022 gilts crisis.

"This suggests schemes are either learning from past experiences or simply adhering to regulatory guidance.”

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