UK pension funds are now actively working towards full-funding as asset returns fuelled by equities lifted schemes’ hopes, according to research.

In UBS Global Asset Management’s annual Pension Funds Indicator report, the manager said achieving full-funding in the current low-yield environment had become the primary concern for pension funds.

It said this correlated with the positive 11% asset performance experienced on average, making the aim more realistic when setting targets.

Leading the returns for UK pension funds was global equities, providing 22.7%, closely followed by UK equities at 20.8%.

Fixed income was less positive, with negative returns of 5.9% on UK Gilts and 6.4% on global bonds, led mainly by poorly performing emerging market debt.

Average pension fund allocations remain relatively stagnant compared with 2012, with around 46% in UK and global equities, 35% in fixed income and 16% in alternatives and real estate.

Despite the negative fixed income returns, Ian Barnes, head of USB Global Asset Management in the UK, said funds would not necessarily be disappointed with the losses.

“Being stung does not have to be a bad thing, as you are always hostage to the timing of investing in an asset class,” he said. 

“Emerging market debt is not being used for liability matching but for diversifying. It has still played a strong risk-reduction role, even if it has damaged returns.

“I do not think we would see a knee-jerk reaction out of the asset class in the near term.”

UBS GAM said discussions about, and allocations to, smart beta had become the most prominent change over the last year.

The report highlighted a growing trend of using smart beta factors to target specific outcomes within portfolios, or using multi-factor strategies that are uncorrelated and add diversification to the remainder of the portfolio.

Barnes said there was a confluence of influences leading to popularity of smart beta and its use as a diversifier.

“Smart beta can be anything you want it to be,” he said. ”You do not even have to believe in the return argument, just that it will perform in a different way, and a different way to deliver equity beta.”

Similarly, infrastructure’s popularity grew, with global assets invested into the class almost at levels seen before the financial crisis.

However, Barnes said belief remained that there was still a “cliff edge” for investors with respect to allocations to the asset class.

“This is more related to the governance hurdles,” he said. “The investment opportunity has been proven, and now the challenge is getting the money in the ground.”

Barnes said the issue also related to infrastructure having high start-up charges, despite long-term benefits, and consistent regulatory pressure for pension funds to focus on fees.

UBS’s study also found defined contribution (DC) assets were now growing at 8.8% per annum, with defined benefit (DB) assets slowing to 5%.

The growth is driven by high allocations to equity from within accumulating DC funds, and the influx of assets via automatic enrolment, which picked up steam in 2013.

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