Consultants Tell Pensions to Embrace Leverage, Complexity

With experts predicting an extension to the lower-for-longer interest rate environment, consultants say defined benefit funds must reassess.



Defined benefit pension funds need to embrace levered and complex strategies or face widening funding gaps as the low-growth, low-interest rate environment looks set to drag on, some consultants have warned.

John Walbaum, head of investment consulting at U.K.-based Hymans Robertson, told Institutional Investor that his group is about to embark on a communications campaign highlighting the importance of “capital efficiency.”

“We think trustees need to think very carefully and come up with plans to use their limited resources as effectively as they possibly can. It’s going to be ever more important in a low-return world,” he said. “That might mean using leverage in a controlled way to boost returns, to generate cash, or to buy you time for other assets to generate a return.”

Walbaum said while trustees have already become comfortable with using leverage within Liability Driven Investment (LDI) programs, which seek to match assets to liabilities in defined benefit pension plans, they now need to consider how leverage could benefit other parts of the portfolio.

Fraser Lundie, co-head of credit at asset manager Hermes, said that non-pension fund investors have already started allocated to “more complex parts of credit” as they have determined that simplicity can be a restriction that “hinders risk-adjusted returns.”


Earlier this year, the International Monetary Fund published its “Global Financial Stability Report” which warned that DB schemes would be “hard-pressed to find a duration-matched, risk free, bond portfolio to deliver the required cash flow in a low-for-long economy.”

[II Deep Dive: Biggest U.K. Companies Face Defined-Benefit-Pension Deficit]

Mercer’s Global Director of Strategic Research Phil Edwards agrees, noting that, he expects returns to be “challenged” for some years because of current equity and bond valuations. As a result, he is encouraging investors to “be a bit more dynamic with the investment strategy.”

Mercer has been working to identify “more complex asset types and asset classes” that will provide pension funds with new options, such as “idiosyncratic multi-asset strategies” like multi-strategy hedge funds or sub categories of diversified growth funds.

Edwards acknowledges that some investors lack the governance abilities execute such ideas themselves, and may choose to delegate these duties to specialist fund managers.

The annual IMF meetings take place between Tuesday, October 10, and Sunday, October 15, in Washington DC.