In a second conversation with ChatGPT-3, it gave me meaningful pointers about UK pensions, after its insight about investment trends for the new year earlier this week. The top risks for 2023 include regulation, low returns, funding shortfalls, climate change and longevity risk. The AI also thinks UK schemes should invest in: alternative assets, private markets, global bonds, sustainable assets and index funds. Here is how it explains its choices. 

 

 

1. AI: “Low investment returns – due to the low interest rate environment and volatile stock markets, low investment returns have made it difficult for UK pension funds to generate sufficient performance to meet their long-term liabilities.” 

 

My 2p: 2022 was one of the biggest bear markets in history, with US equities losing nearly 20% in value and the fallout from the mini-Budget and rising rates is still felt in bond markets. 2022 also marked the end of low interest rates – but volatility is expected to continue as global recession fears show in global trading activity. 

 

2. AI: “Funding shortfalls – a number of UK pension funds have been running funding deficits for some time, resulting in increased contributions from both employers and members.” 

 

My 2p: Insufficient funding is certainly the single biggest obstacle on the road to DB endgames. However, despite the LDI crisis of 2022, funding levels have actually improved for unhedged liabilities, thanks to rising interest rates – and many schemes find themselves both closer to buy-out, but also significant maturity… which may put a strain on sponsor contributions under the upcoming new DB funding code. 

 

3. AI: “Longevity risk – pension funds have to deal with the increasing life expectancy of their members, which means they need to set aside more money to cover the longer-term pay-outs that they will have to make.” 

 

My 2p: Last year’s Trustee Report revealed longevity risk as the top risk that schemes believed would affect their abilities to pay pensions – which was a surprising finding. However, an early read of the data from the upcoming Trustee Report 2022 suggests longevity risk has fallen off the radar and is replaced by other concerns. More on this later this spring! 

 

4. AI: “Regulatory requirements – pension funds are subject to a variety of rules and regulations from the Financial Conduct Authority, Pension Protection Fund and other regulatory bodies, which can add additional costs and compliance burdens.” 

 

My 2p: The DB funding code is in its second consultation, which will close in March 2023. In addition, the PPF is reviewing its rules for buy-out valuations, to get more in line with insurers practice. 

 

At the same time, TPR is introducing a new single code of practice for pension trustees, which requires an Effective System of Governance and Own Risk Assessment frameworks to be put in place. Pension dashboards deadlines are looming for large schemes, and DC pensions face an ever-growing push to prove value for money, improve member engagement, as well as increase investments to illiquid assets. Yes, regulatory complexity is only about to increase! 

 

5. AI: “Climate change – it is a growing issue for pension funds as they invest in companies that are exposed to climate risk. Schemes are having to consider the climate impact of their investments and how they can reduce their carbon footprint.” 

 

My 2p: The single code of practice for trustees increases ESG engagement, implementation and reporting requirements. In addition, schemes over £1bn are now required to provide TCFD reporting and set climate targets. At the same time, public pressure on preserving biodiversity and natural capital is growing, and nature-related risks and opportunities will likely be added to the pensions agenda soon. 

 

 

1. AI: “Investing in alternative assets – infrastructure, private equity, and real estate can provide diversification and high returns for pension funds.” 

 

My 2p: In addition to the allure of private markets as a haven in public market volatility, alternative assets often play a key role in the climate and energy transition – take infrastructure as just one example. While access to alternative assets can be uneven for schemes of different nature and size, regulatory reforms are underway to improve that – and new solutions blending illiquid alternatives with liquid proxies are coming to market. 

 

2. AI: “Investing in global bonds – they can provide a steady source of income and can be used to hedge against inflation.” 

 

My 2p: Of course, not all bonds provide an inflation hedge, and 2022 has reset the game in bond investing, leading many managers to adopt a dynamic or barbell approach. However, global bonds remain a dominant component of what TPR assumes to be a representative asset allocation for schemes at significant maturity – and a staple of LDI and matching portfolios. 

 

3. AI: “Investing in index funds – they offer a low-cost way for pension funds to gain exposure to a broad range of markets.” 

 

My 2p: Passive investing remains popular among DC schemes due to its low cost and high liquidity – however, this may change as a result of increased access to alternatives and plans to exclude performance fees from the DC charge cap. 

 

4. AI: “Investing in sustainable assets – green bonds and renewable energy can provide both financial and environmental benefits.” 

 

My 2p: The pressure to decarbonise investments and support the climate transition is growing without a doubt. Green bonds and renewable energy are just the tip of the iceberg – 2022 saw increased offering of social bonds, sustainability bonds, impact and natural capital funds investing across the capital structure. However, capacity remains limited, and many schemes still seek to understand how such assets can fit a de-risking path or DC default portfolio. 

 

5. AI: “Investing in private equity – such investments can provide access to high-growth companies and offer superior returns for pension funds.” 

 

My 2p: The AI doubled down on this bet – but how correct was it to do so? On one hand, there is limited room for growth assets in both a de-risking DB portfolio, as well as a DC default fund, both of which aim to preserve capital over time. However, under the draft DB funding code of practice and its Fast Track requirements, TPR assumes that a scheme within five years of significant maturity may be investing approximately 60% in growth assets. However, whether the industry believes they offer good value for money is a different subject altogether. 

 

 

The power of AI has increased exponentially just in the last few months of 2022. As we at mallowstreet Insights grow more familiar with its rapidly expanding functionality, I reflect on two things: 

 

 

Check out what the AI had to say about 2023 investment risks and opportunities here.