European pension funds are increasingly worried about the potential impact of inflation shocks on their portfolios as markets remain volatile, according to research conducted by Mercer.
The consultancy’s annual European Asset Allocation Survey of more than 1,100 European pension funds found that 80% of respondents are now more concerned about the threat of increasing inflation than they were last year, and many are taking action to protect their assets.
It was found that 38% of the funds concerned about inflation are planning immediate action to protect against any shocks and 18% are planning to increase their allocation to inflation-linked bonds, while 5% are allocating to inflation-sensitive assets and 3% to inflation swaps.
The remaining 12% have taken other actions such as establishing processes to exploit opportunities as they arise either through the use of discretionary management or by introducing a series of triggers that, once hit, will increase their allocation to inflation bonds or swaps.
Both Ireland and the UK have a bias to equities though this continues to decrease year-on-year. In the UK allocation to equity is currently at 47%, down from 50% in 2010. Most of the recent UK reduction has happened within the domestic equity portfolio, down from 28% in 2009 to 21% now. Irish funds have seen a record reduction in average equity allocations since 2010, dropping from 59% to 50%.
Tom Geraghty, head of investment consulting for Europe, Middle East and Africa at Mercer, said: “The last 12 months have been characterised by a general sense of unease and rapid swings from optimism to fear and back again.
“The use of loose monetary policies and quantitative easing has created the ideal environment for the re-emergence of inflation, which is a cause for worry for many pension funds.
“Protection, through acquiring inflation hedging assets (such as inflation bonds and swaps), looks to be expensive and there is a risk that such investments provide ‘insurance’ for events that never actually happen. Pension funds also need to understand the extent to which their liabilities are affected by higher inflation. In some cases, inflation caps may mean that higher inflation is less negative for pension schemes than might be expected.”
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