EUROPE – The needs of pension funds have changed, which has resulted in a new era in pension fund products, says Watson Wyatt Worldwide partner Susan Douse.

As pension funds assess the situation in the wake of the three-year bear market, they are now looking for new products to match their changed needs - this was Douse’s message to the PensMart 5th Annual European Pension Market Forum in Frankfurt.

The 20-year bull market had seen very little emphasis on liability matching, with investors focusing on returns. "Risk budgeting did not receive enough attention, and now we are seeing a need to reflect more on liabilities." Asset allocation is now key - and she made reference to Watson's push for "dynamic asset allocation".

According to Douse this means that pension funds will be looking more at active management, absolute return mandates, and will be looking to work their assets harder. The trend towards absolute returns was also cited by Robert Parker, deputy chairman of Credit Suisse Asset Management, and Martin Theisinger, managing director of Germany and Austria at Schroder Investment Management.

Douse feels that the way asset classes are viewed will change to just two - risk minimising assets (bonds), and return maximising assets (growth assets, such as equities, hedge funds, alternatives).

In the latter class, she forecasts more interest in enhanced diversification - new strategies, long-short, fund of hedge funds, new balanced products. There is still a role for passive strategies she adds, but interest will lie with enhanced index products.

Skill will be critical, as investors look for alpha maximisation.

In the fixed income arena, cash-flow matching strategies will be attractive, and there will be more to do with swaps - and therefore investment banks will become involved. Passive strategies here will also be enhanced index, and skill will be critical. High yields, emerging debt and leveraged credit will become key within the umbrella of bonds.

As diversity is sought, constraining benchmarks will lose favour, and performance measurement will become more short-term. Douse also predicts an increase in the level of shareholder activism.