The markets in 2023 – Cover story
I would not want to be alarmist and say the boom in private markets is over, but there will be slightly less demand.
Mike Eakins, Phoenix
Mail Pension Scheme, were forced to bring forward their spon- sor contributions to mitigate the effect of the liquidity crunch. At the same time, improved funding ratios mean that talks of the endgame have been dramatically pushed forward and will continue to dominate in 2023, predicts Alan Pickering, presi- dent of Best Trustees, an independent trustee services special- ist. “I am encouraging all of my schemes to take stock once the dust has settled from the liquidity crisis,” he says. “It is impor- tant that employers and trustees get their heads together to review what their objective is. Is it to continue in a steady state, or is to move towards risk transfer via a buyout or a consolidator?
“That means two or three hours with the employer and trus- tees to take stock of how close they are to buyout or buy-in and what impact that proximity should have on their asset alloca- tion,” he adds.
Indeed, the rise in gilt yields means that nearly one in five DB schemes are now fully funded on a buyout basis, with the cost of handing liabilities to an insurer more than halving to £1trn, from £2.3trn in 2021, according to Lane Clark & Peacock. The consultant predicts that demand for buyouts and buy-ins could hit £200bn during the next three years, with £60bn of transac- tions in 2023 alone.
This would exceed insurer capacity. Alan Pickering, who is also
chair of trustees at Clara, predicts that pension consolidators, like Clara, could meet growing demand. In investment terms, rising interest in buyouts means that these schemes will be less inclined to venture into illiquid asset classes. But on the other side of the DB spectrum, schemes which remain open, such as the local government pools, have, in some ways, benefited from the crisis. For them, diversification into illiquid assets could become increasingly important. This ties into a global trend. More than half of asset owners world- wide (52%) expect to invest more in private markets next year, according to investment consultancy Bfinance. Open DB schemes have benefited from the fall in liabilities and more favourable exchange rates for overseas investments, Mark Lyons of Border to Coast says. “Thanks to our globally diversified portfolios, where the majority of earnings are from overseas, local government pension scheme funds have tended to benefit from the fall in sterling,” he adds. In 2023, Lyons also sees opportunities in bonds. “Higher yields also provide more opportunity to generate income from bonds, and positive real yields on index-linked gilts might even enable some funds to hedge inflation risks.
“Investors would be well placed to wait until prices have adjusted to reflect the impact of higher interest rates on the markets. They could also wait until the credibility of the gov- ernment and Bank of England has been properly restored,” he adds. But despite these short-term headwinds, Lyons also predicts that the new year will be difficult for open final salary schemes. “The challenge facing local government pension funds is that they will need to adapt their strategic asset allocations to a ‘new normal’ – a more inflationary environment with rising interest rates.
“Rising inflation will result in higher pension costs, so gener- ating income will be increasingly important in the coming years,” he adds. “Asset classes such as infrastructure, property, healthcare and higher-income long-term real assets will likely be more attractive to tackle this growing risk. “However, it is important to stick to a long-term approach, buy- ing income streams at the best price, rather than reacting to short-term volatility.”
DC: Branching out
Diversification is also the name of the game for defined contri- bution (DC) funds, which have faced a double whammy of fall- ing equity markets and plunging bond prices, making it bad news for members who are close to retirement. Indeed, many retirement stage default funds are on track to end the year with double-digit losses.
And even default funds in the growth stage are in the red for the first time in years, due to their exposure to US equities. For
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