Defined benefit schemes have become more defensive in their investment strategies, reducing growth assets while diversifying fixed income portfolios, the latest DB survey by Russell Investments has found, as a desire to be buyout ready combines with growing fears about possible market sell-offs, volatility and the risk of recession.  

The report published on Wednesday, which surveyed 104 stakeholders representing almost £250bn in assets in autumn and winter this year, found DB schemes are reducing growth assets and diversifying fixed income as they derisk and react to tight investment grade credit spreads.  

“Schemes are still looking to allocate to investment grade credit, but particularly the larger ones are looking further afield, into high yield, into securitised types of assets and even private credit,” said Simon Partridge, head of UK fiduciary management at Russell.

Investment grade credit and government bonds have kept their positions as the most popular asset classes, but a striking 17% of respondents said they plan to allocate to private credit, up from 7% in 2024.

Meanwhile, 13% want to invest in high yield, up from 10%, and 12% named insurance-linked securities – double the proportion that said so last year. Demand for these less mainstream strategies comes predominantly from large schemes.

As DB investors look to diversify within fixed income, some have cautioned that this can bring risks too.

“These [ABS and similar assets] are very specialised sectors where people may not understand the correlation of risk... and so what is perceived as lower risk may actually be higher risk,” said Miki Fairfax, a professional trustee at Bestrustees.

More risk is unlikely to be what schemes are looking for; market sell-offs, volatility and the risk of recession were of increased concern for defined benefit schemes this year, though the biggest challenge they cited was geopolitical conflict.
   

 

Schemes are also selling down illiquid assets, reducing property and private equity, as well as developed market equities. Another 14% hope to offload some emerging market equities. 

Plans to sell illiquid holdings could reflect a desire to lock in high funding levels and accelerate buyout plans. For trustees, liquidity and execution readiness were key, given that 38% continue to target buyout, according to the report, rising to 50% among schemes with more than £1bn of assets.   

However, as many as a third (32%) aim for low dependency run-off or run-on, while 30% are still undecided amid changing surplus regulations and a widening of endgame options.  

Interestingly, while some schemes are looking to invest in private credit, others see it as an asset they want to sell; 14% are looking to unwind positions, rising to 17% among larger schemes.  

Russell Investments is watching news around private credit – Partridge says the biggest issue with it revolves around liquidity.  

“When we are talking to our clients about potentially diversifying into less liquid asset classes, we wouldn’t be looking at the traditional approach, which was to go into a closed-ended client, lock up for 10 years and just wait till the end. We very much advocate more of a semi-liquid type structure,” he said.  

Semi-liquid means funds providing at least quarterly liquidity after an initial lock-up period, but Partridge pointed out that even with that, the risk tends to be higher in private markets, with no guarantee of returns.  

“The other aspect around private markets that is always there is the need for proper due diligence,” he added, stressing that investors need to know what they are buying.  

Infrequent valuations can also be an issue particularly during market downturns – something that came to the fore in late 2022 and early 2023.

Russell is less cautious about other asset classes, taking a neutral view on equities, where high valuations of AI companies have created fears of a bubble. 

Van Luu, global head of solutions strategy – fixed income and foreign exchange at Russell, said the firm’s proprietary sentiment indicator does not indicate euphoria at present, and believes the benefits of AI are starting to be seen more widely across the economy, rather than just the tech sector.  

He said there is now an “inflection point where the benefits of AI are shifting from the builders of AI to the users, and I think that will help to broaden out the growth drivers and also market returns”.  

Conversely, “the biggest risk, and the biggest watch point, is weak US hiring, but it seems so far that is policy-driven rather than cyclical weakness” rather than reflecting lower demand from employers, he added, citing cuts in US government jobs and restrictions on immigration.  

Luu said gilts currently look attractive as the Bank of England is expected to cut the base rate. However, Russell is underweight corporate bonds given the additional supply coming on the market from AI ‘hyperscalers’.