More than half of UK defined benefit pension funds are now paying out more in pension payments than they are bringing in through investments and contributions, according to research by Mercer.

The consultancy group’s latest European Asset Allocation survey reported that 55% of DB schemes were “cashflow negative”, based on a sample of nearly 600 UK schemes.

Of the remainder, 85% expected to be cashflow negative within the next decade.

At the same time, allocations towards alternative assets – including less liquid asset classes – rose during 2016, Mercer reported. Phil Edwards, global director of strategic research, warned that schemes should maintain a sufficient allocation to liquid assets to ensure they can meet cashflow demands.

“Being cashflow negative is a natural life stage of a mature DB pension scheme, of course, but recent stock market performance may have lulled some into a false sense of security,” Edwards said. “Our report highlights that less than 40% of schemes have a formal de-risking journey mapped out. This leaves a large body of schemes with no clear plan in place.

“Trustees of cashflow-negative schemes need to be sure that, in the event of a large market correction, liquid assets are available to meet cashflow and collateral needs, without requiring the scheme to crystallise losses. We would encourage all schemes – large and small – to use scenario planning and stress-test analysis to understand how a market correction might impact their financial health.”

The majority of pension funds sell assets to meet payments, Mercer found. However, nearly a third (29%) have begun focusing on income-producing assets to reduce the impact of transaction costs.

In addition, a “small number” of schemes have adopted “cashflow matching” strategies, attempting to pair up income and other receipts with actual payments as they fall due.

“The popularity of cashflow matching is clearly set to grow over time and we are already seeing an upswell in interest in the cashflow-driven financing approach,” said Adam Lane, senior strategic solutions group consultant at Mercer. “In our view, focusing on income generation provides much greater certainty of return over the long term than more traditional approaches, while also reducing the path dependency of outcomes.”

Earlier this year, Henderson Global Investors launched a “cashflow-driven investing” strategy aimed specifically at pension schemes reaching this milestone.

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