Larger UK DB schemes prefer to run on but growth assets are off the menu
Upwards of two-thirds of large DB pension schemes are pursuing run-on strategies, but the preference is to use surplus funds to enhance member benefits (Andy Rain/EPA/Shutterstock)
The majority of large defined benefit schemes are pursuing run-on strategies, but relatively few are eager to invest surpluses into UK growth assets. Instead demand is expected to remain concentrated in liability-driven investment and cash flow-matching strategies, consultants say.
Upwards of two-thirds of large DB pension schemes are pursuing run-on strategies, but the preference is to use surplus funds to enhance member benefits, according to Legal & General Investment Management data.
L&G's recent Endgame Insights survey shows that schemes are split broadly evenly between using surpluses to boost member benefits, returning funds to sponsors and supporting defined contribution sections of pension trusts.
But only a "small minority" are focusing their attention on investment in UK assets, the report found.
This runs in contrast with the government's desire to use the pension schemes bill to deploy some of the estimated $179bn in surplus funds for UK productive finance.
Yona Chesner, head of investments in the north of England at pensions consultancy Cartwright, confirms that even large DB pension schemes are less willing to explore growth assets.
"[Among] schemes that haven't done risk transfer [deals with insurers], most... I would say, have done significant amounts of risk reduction, so they'll have sold off a lot of their growth assets over the past decade," he tells MandateWire Analysis.
"Very few schemes [have] 60-70 per cent growth [assets] any more."
Instead, Chesner says, demand for liability-driven investment strategies is expected to generate further opportunities for asset managers to work DB schemes, particularly as smaller schemes shift towards buyout and adopt pooled LDI funds.
Around half of the 76 DB schemes surveyed (49 per cent) by L&G had funding levels strong enough to head to the buyout market, providing fertile ground for trustees to have discussions on what a scheme's "endgame" would look like once all liabilities are met.
“Run-on strategies could “provide value for members and employers, and in doing so have a positive impact on the economy further down the line”
While many are ready to sign a buyout deal, L&G found that 70 per cent of large DB schemes were considering running on, increasing the onus on managers to provide appropriate cash flow-driven and LDI strategies as DB schemes seek to protect their funding positions.
According to XPS Group's recent DB Surplus report, cash flow-matched strategies are a central part of "solid risk management" for DB schemes, which the consultancy says allows DB schemes to invest in an insurer-like manner.
"Insurers generate stable profits by matching assets to liabilities and capturing net returns. Pension schemes can adopt similar principles — delivering meaningful and stable returns while ensuring benefit cash flows are well matched," XPS's report notes.
Schemes running on will need to define their risk tolerance and build an "efficient portfolio", which will "generate the highest return while staying within that tolerance", says L&G.
"They will still need to diversify rewarded risks, seek to protect against unrewarded risks, and carefully manage liquidity," the report adds.
UK growth assets through greater DC investment
Simeon Willis, XPS Group's chief investment officer, says that while it is "not the role of UK DB schemes to prop up the UK economy", run-on strategies could "provide value for members and employers, and in doing so have a positive impact on the economy further down the line".
WIllis says that if funds are transferred over to DC sections of pension trusts, these "may be well placed to invest more directly in UK productive finance".
Nearly three-fifths (57 per cent) of schemes in L&G's survey were considering surplus extraction, which could go towards supporting DC sections, potentially leading to higher growth asset investment.
XPS's report estimates that the average $1.3bn scheme could expect a $226mn surplus in average market scenarios, potentially providing significant sums at trustees' disposal.
Some uncertainty remains around the potential for surplus extraction by DB schemes, as the regulations and guidance governing surplus extraction are still being consulted on by both the Department for Work and Pensions and the Pensions Regulator.
Their findings are not expected until the end of 2026, with rules coming into force by April 2027.
However, some schemes are already using surplus funds to support DC sections.
Last year, the $702mn DC component of the Schroders Retirement Benefits Scheme's trustees worked alongside its actuarial consultant Aon to free up a portion of DB surplus funds to "partially subsidise the company's contributions into the DC section".
Meanwhile, L&G has also offered DB trustees technical support to free up surpluses for DC sections. Doing so can help to lower costs for scheme-sponsoring employers and improve saver outcomes, all while abiding by scheme covenants and tax regulations.