Almost a third (30 per cent) of UK defined benefit (DB) pension schemes are yet to decide their endgame target, with many more willing to consider their options rather than move automatically to buyout, research from Russell Investments has revealed.

Russell Investments’ UK Defined Benefit Market Insights Study showed that while buyout remains the most popular option for schemes, improved funding levels have reduced the pressure to move immediately to buyout, with the proportion of schemes looking to run on/off increasing by 33 per cent in the last twelve months.

“The material improvements that pension schemes have largely experienced in funding levels are causing decision-makers to consider their long-term options with respect to endgame," Russell Investments head of UK fiduciary management, Simon Partridge, said.

"While buyout will inevitably remain the solution for many, particularly those at the smaller end of the spectrum where moving to an insurer makes the most economic sense, we are beginning to see a greater openness among schemes to explore the range of options open to them."

Despite this uncertainty, the analysis found that DB schemes are seeing an acceleration in the move towards endgame goals, as nearly a third (32 per cent) expect to reach their endgame target within one-three years, an increase from 25 per cent since autumn/winter 2023.

Anecdotal evidence from the study suggested that exposures to illiquid assets are a determining factor in schemes’ thinking and timeframes, with those still considering buyout as their ultimate endgame option preferring to run-off these assets over time rather than risk the potential for losses by entering the secondary market.

Notably, as a result of this trend, DB asset owners are now considering their medium- to long-term investment strategies and asset allocations, recognising the need to improve levels of return in order to maintain their current positions.

Indeed, Russell Investments found that 29 per cent of schemes are placing greater emphasis on increasing levels of return, while a further 29 per cent are prioritising cashflow generation as they consider their endgame options.

This trend is particularly pronounced among smaller schemes (those with less than £1 billion of assets), with one-third (33 per cent) of respondents seeing the need to improve levels of return as a priority, an increase of 10 per cent compared to the previous study.

This was not the only shifting trend, as, in something of a reversal of Russell Investments spring/summer 2023 study, the latest study found that asset allocation focuses have moved back towards fixed income, with a particular focus on investment grade credit where over one-quarter (27 per cent) of respondents expect to increase allocations in the next six months.

The proportion of respondents planning to increase allocations to infrastructure has almost doubled (to 11 per cent), which the firm suggested could be reflection of the diversification and income benefits of this asset class, particularly for those schemes considering run on/off either on an interim basis or over the long-term.

This growth came primarily at the expense of developed and emerging market, with just 9 per cent of DB schemes planning to increase developed market equity holdings and 7 per cent to emerging market equities.

Property remained the asset class that pension schemes are likely to decrease exposure to, however, with 43 per cent seeking to reduce their allocation in the next six months.

Private equity and private debt also continued to face challenges relative to other alternative asset classes, with 32 per cent and 30 per cent respectively of current holders planning to decrease their allocations.

Environmental, social and governance (ESG) issues are also slipping in terms of scheme priorities, as the research found that the importance attached to improving sustainability and ESG has fallen "sharply", with 34 per cent identifying this as a current investment priority, down from 45 per cent in spring/summer 2024.
.
Anecdotal evidence from the study’s focus group suggested that this may be due to decision-makers prioritising other areas, as well as due to limitations of investing in assets – primarily fixed income – which are perceived as less conducive to pursuing an ESG agenda.

However, respondents did highlight growing appreciation for allocations to areas such as infrastructure with these assets seen as being naturally conducive to meeting ESG objectives.

“The last two years has seen a rapid evolution within the DB pensions market. While this has been beneficial for many, it has brought with it a number of new, complex considerations that decision-makers have to contend with," Partridge commented.

"They will need to carefully assess their options in order to identify the endgame solution most suited to their scheme, membership and sponsor, balancing the opportunities that improved funding positions can provide against various market, governance and regulatory challenges.

"The effective use of resource, including outsourced support where required to provide both strategic guidance and operational capabilities, will be critical for schemes to successfully navigate this more complex landscape.”

---