The majority (90 per cent) of US public sector pension plan managers expect to increase their scenario modelling and stress testing in the next two years, research from Ortec Finance has found.
This increase is due to concerns around the potential impact of economic and market shocks, the report says, with US public sector pension plans having been put under pressure by recent inflation hikes and interest rates.
However, inflation concerns are tapering off. 90 per cent of respondents were confident that it is “on the decline”, with 52 per cent expecting rates to drop to 3.3 per cent or below within a year. Only 10 per cent anticipate inflation rates to exceed 6 per cent within this timeframe.
Additionally, 86 per cent of those polled stated that their plan is well hedged against inflation. 26 per cent say they are “very well hedged”, with just 12 per cent rating their hedging against inflation as average.
In order to continue successfully hedging against inflation, 66 per cent expect to increase allocations to commodities and 50 per cent to infrastructure investment. 38 per cent say they will increase allocations to gold, and 32 per cent will allocate more to inflation-linked bonds.
In the past year, 14 per cent of pension plans in the study had funded ratios of 60 per cent or less. Only 12 per cent had funding rations of 100 per cent or more. Overall, average funded ratios were at 77.89 per cent.
Risk profiles have been altered in response to this, with 81 per cent of respondents expecting to increase risk profiles over the next year and 32 per cent anticipating this increase to be dramatic.
Scenario modelling and stress testing was supported by the majority of those polled, with 44 per cent finding them “very effective” and 56 per cent deeming them “mostly effective” when it comes to asset liability management.
Marnix Engels, managing director of pension strategy at Ortec Finance, says: “The degree of uncertainty is extremely high for US public sector pension plan sponsors but there is genuine optimism that lower inflation will become well-established, with very few managers expecting it to be as high as it currently is within a year or two.
“The major challenge, however, remains that funded ratios are under pressure. This stresses the importance of asset-liability management to improve the long-term financial position of the plans. The stochastic models currently available to sponsors and their advisor are too simplistic and may generate results that do not fully account for major economic and market shock events. It makes sense to increase spending on advanced tools that offer more realistic and useful insights in changing market conditions.”
