The past year has been a turbulent time, with unprecedented surges in the gilt yield markets following the mini-Budget, increases in inflation, and an uncertain horizon prompting many pension scheme trustees to review their investment strategies.

Indeed, recent research revealed that nearly half (44 per cent) of global investors are not satisfied with their overall performance in 2022 so far, with particular concerns raised around inflation and rising rates, as well as the looming threat of recession.

Isio partner, Ed Wilson, also suggested that the aftermath of the liability-driven investment (LDI) crisis will have prompted “almost all” UK defined benefit (DB) to revisit and significantly revise their investment strategies.

“The market turmoil has left schemes’ actual asset allocations very different from their pre-existing strategic asset allocations, but before trustees rebalance their assets back they must reassess what they now need from their investment strategy in 2023,” he explained.

Adding to this, BlackRock head of UK fiduciary business, Sion Cole, warned that the “great moderation” is over, suggesting that pension trustees will need to ensure that their investment strategies are correctly positioned to protect funding levels in case of a downside scenario.

"Earlier in the autumn, the UK experienced this new regime of higher volatility, which highlighted the brutal policy trade-off between growth and inflation," he continued.

In particular, Cole highlighted an increased focus on active management as a key consideration for the year ahead, as well as a potential rethink on bonds.

“We believe pension schemes – alongside all investors – will need to reassess the risk/return profile of fixed income – especially compared with risk assets, such as equities," he stated.

"In this context, we favour inflation-linked bonds as we continue to see long-term drivers of the new regime, such as aging workforces, keeping inflation above pre-pandemic levels.”

In addition to this, Cole suggested that the pension industry will need to evolve towards higher collateral buffers within LDI funds following the recent events in the UK gilts market, which means reduced portfolio leverage across the pension sector.

“Additionally, schemes will need to keep an appropriate level of liquidity in the overall portfolio, including in the growth portfolio, in case of any urgent cash calls," he added.

"We believe private market allocations will remain central to growth portfolios, but the size of allocations will need to be appropriately assessed – especially given the drawdown over the year-to-date.”

This is echoed by Capital Markets head, Chris Arcari, who suggested that a renewed focus on building collateral will likely lead to a "revival in allocations to equities and liquid credit which may have previously been replaced by solutions promising a lower but steadier return profiles".

Fulcrum Asset Management director, Chris Gower, also urged investors to factor in the macroeconomic environment as a key variable in their asset allocation decisions, especially as it relates to diversification.

He stated: “Most portfolios assume a world dominated by demand shocks with a negative correlation between equities and bonds.

"While this has worked for the last thirty-plus years, in our view, the current macroeconomic environment will remain dominated by supply induced shocks.

“With expected returns of stocks and bonds at historical lows and in an environment dominated by supply and demand shocks, bonds will continue to offer far less protection against equity risk.

"This could be a year where it pays to factor in more structurally that diversification is not a constant, and that macroeconomic-oriented investment strategies that invest in a broader range asset classes, such as commodities, could offer valuable protection against further inflationary shocks.”

Adding to this, Arcari stressed that the pain felt in markets over the past year has also created opportunities, explaining that the headwind to returns posed by high valuations has eased and is, in some cases, becoming a tailwind.

He continued: “Longer-term, forward-looking return expectations have moved significantly higher across the major asset classes given the current lower prices and higher sovereign bond yields and policy rates.

However, Arcari acknowledged that despite the much more attractive long-term entry points across markets, near-term challenges remain, as markets contend with the fundamental impact of high inflation and interest rates that has already shaken valuations.

“While entry points are much more attractive than previously, the period of sub-trend growth required to bring supply and demand back in to balance, could mean further near-term weakness," he explained.

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