Going for growth: changing funding targets drive investment decisions

Our latest fiduciary research report* shed light on the shifting sands of decision making since the need for defined benefit (DB) schemes to establish a long-term funding target (LTFT) was announced by the Pensions Regulator in 2019.

LTFTs have been reassessed

Once again, we find LTFT objectives remain fluid, with more than two-thirds (69.5%) of schemes that have set an LTFT changing their objective this year. This is on top of the 56% of schemes that said their endgame had changed last year. Three-quarters of small schemes who have set a target (74.6%) said that target had changed in the previous twelve months. A similar number of medium-sized schemes (76.1%) had changed their target, whilst just over half of larger schemes (53.2%) have changed their strategy.

Definitions: Small schemes are those with less than £100mn in assets; medium-sized schemes have between £100mn and £500mn in assets; larger schemes are those with more than £500mn in assets.

Interestingly, 80% of small schemes say they are yet to set a funding target, although 56% expect to do this by the end of 2025. Two-thirds of medium-sized companies are yet to establish an LTFT with almost a quarter expecting to do this by year end. And three-quarters of larger schemes have made no decisions, but half of all schemes should have an LTFT in place by the start of 2026.

How have LTFTs changed?

Just under a third of schemes (31%) now say they are looking to consolidate within a superfund and almost the same number (31%) say they are seeking a buy-out by an insurer. Less than a quarter (23%) say they will pursue self-sufficiency. This has historically been the preferred option but has fallen to third place.

Self-sufficiency might have fallen in popularity as continuing market uncertainty impacts funding positions, with the potential to expose scheme sponsors to additional costs. Meanwhile, those that have not set their funding target, which represents the vast majority of schemes, are having to function as if they will remain responsible for meeting the scheme’s liabilities in line with self-sufficiency.

There are also concerns about insurance company capacity for buy-outs and questions about whether this can be an option for all schemes. Insurers may be selective in the schemes they are willing to accept, and this might force trustees into a rethink in the future.

Going for growth

With many schemes now in surplus, improved funding gives them more flexibility to deliver better returns and reduce funding requirements from sponsors. Naturally, this is popular with sponsors, who would rather not have to prop up their pension schemes, and two out of five trustees (40.7%) reported this as a primary driver of investment decisions. Smaller schemes were the most likely to cite this as the reason (48.7%) for selecting this investment strategy.

Moreover, a growth strategy focused on equity returns is highly compatible and a natural choice for schemes pursuing self-sufficiency or consolidation within a superfund vehicle.

However, the most attractive assets for insurers tend to be high profile, highly rated corporate bonds. Trustees therefore need to be mindful of this in the coming years if this is to be their preferred option. As we have discussed above, with insurers limited in their ability to accept more liabilities, those schemes with the most attractive assets (to insurers) will be given preferred status.

That being said, bond investments tend to provide lower total returns to the scheme, and this could make them unattractive on a valuation basis. This is the juggling act trustees will have to manage carefully.

How is this being reflected in investment decisions?

With a focus on growth, it was no surprise that we found 43.5% of schemes increasing their exposure to equities. This was more prevalent among medium-sized schemes at 61.2% followed by smaller schemes (34.9%). Less than a third of larger schemes (29.8%) have increased their exposures to equities.

Interestingly, the same order of schemes (42.9%) said they had increased their exposure to illiquid securities. This is despite 97.2% of trustees saying their schemes had had problems selling assets as fast as they would have liked in the previous 12 months. For more than a third of trustees (36.6%) this was a serious issue; for almost half of trustees (49.3%) it was a moderate issue; and for 11.3% of trustees, it was a mild issue.

Illiquid assets can also be problematic for insurers, so the rise in schemes investing in this part of the market suggests they may be pursuing alternative options to buy-out.

About the report

Now in its fourth year, Charles Stanley Fiduciary report offers an important snapshot into the issues trustees are facing today, and how they are meeting them. A lot has happened since we first launched the reports; politically, economically, socially, and in the worlds of investment and regulation.

Download your copy of the report to find out more.

*Research was carried out by Censuswide among 71 professional pension trustees of UK DB pension schemes, who manage an average of five DB pension schemes each, with an average scheme size of £415 million. The survey was completed between 22nd July 2024 and 2nd August 2024.