Pension schemes across Europe are grappling with how best to turn volatility from risk into opportunity. This study looks at what trustees are doing in current market conditions

The third annual survey of European pension funds by sister title PWM, organised in conjunction with Pyramis Global Advisors, reveals pension funds across Europe are still strategising to come to terms with the low-return investment climate and above-average market volatility.

Attractive costs and flexible options are opening up the benefits of ETFs to a much wider audience than merely the retail marketplace.

Exchange traded funds (ETFs) were once just the playthings of retail investors, but in recent months institutional clients have been getting in on the act. A handful of local government pension funds have admitted to using them, and some of the bigger FTSE 100 schemes are reported to include them in their portfolios.

Despite glum predictions for green investment during the credit crisis, SRI has continued to grow and is set for further expansion as energy prices rise and carbon taxes increase

Within the pensions industry, interest in investing in currency is mounting yet remains beset by disagreement; while some are drawn in by attractive opportunities for return, others fear its propensity to correlate with equities.

Additional advantages of currency investing include liquidity, low dealing costs and its relatively low correlation with other assets. But some say ramifications of the credit crisis in 2008 make it too risky an asset class.

The quantitative easing (QE) programme – or as it was in September, simply the prospect of QE – can have a powerful and positive effect on equities. Even so, in these testing times equities are an attractive asset class, and offer compelling value relative to government bonds or cash.

Asking any fund manager or an investment consultant which strategies have been skillful and which have been just plain lucky trends over the past few years, could be seen as a cruel and unusual punishment. The question tends to elicit long pauses and much agonising. The crashes in stock market values of 2003 and 2008 have made fools of most in the investment world.

What were supposed to be once-in-a-generation events caught nearly everyone out, if not by the turn events, then by the severity of the fall. Many who boasted they were doing well in 2007, now realise these returns were more the result of luck than skill.

Exchange traded products (ETPs) have become a mainstream investment since the first European products became readily available 10 years ago. Recently, many large pension funds have become increasingly attracted to ETPs. This has been especially true through the recent credit crisis, with close to $1trn being invested in such products as investor appetite has swung away from active management to passive and index-hugging products.

Legislation requires the increase of defined benefit (DB) pensions in payment and the revaluation of DB deferred pensions to take account of price inflation. Traditionally the government has used the retail prices index (RPI) to determine indexation and revaluation factors.

First, the numbers. There is about £700bn of inflation-related liabilities in UK pension funds. Taken together with insurance companies, that demand is more than £1trn.

The index-linked gilt market is £170bn. This is a huge imbalance. Consequently, real yields have fallen and are now below 1%, falling as low as the 0.5% mark.

Issuers of inflation swaps are hedging their risk with index-linked gilts, simply moving the demand around.

While the government has some more issuance yet to do, its emphasis on deficit reduction will do nothing to right this imbalance in the liability-driven investment (LDI) market.

Since the onset of the lending liquidity squeeze in 2007, adverse market experience in the more traditional asset classes of equities, fixed income and property have had a number of impacts on the fortunes of pension funds.

Government bonds are among the most basic and liquid instruments available for investors to trade. However, all too often, fund managers are content to use an outdated system of portfolio management that reduces the potential for them to generate alpha for their clients.

UK pension funds have witnessed sterling returns of 0.96% for global equities in the past 10 years (to March 31, 2010) with high levels of annual volatility. This includes two protracted periods of equity market weakness, the first driven by the bursting of the dot-com bubble and the second by the credit crisis. As in 2001/2002 investors have questioned the roles of active management and equities. With increasing longevity, a sharper focus on the sponsor covenant and tighter regulation, this questioning is easy to understand. Nevertheless, equities have delivered positive returns during bull market phases over the past decade, suggesting UK pension funds need to be more nimble in their asset allocation and more sophisticated in how they approach total return risk management.

Currency is a non-traditional field for pension funds, but those taking part are revitalising the market.

The hedge fund industry is beginning to recover from a tumultuous two years, but the ensuing regulatory directive coming in from Europe could put added pressure on managers at an already difficult time

Improving mortality rates pose a fiscal threat to schemes and longevity swaps are one way to hedge against these risks – but their complexity can bring further problems

When and whether to hedge against liability risk is a decision that demands great consideration

The government’s quantitative easing initiative has seen in excess of £175bn pumped into the UK economy, but what overall effect has this had on the position of gilts?

Investors are advised how to get the best from European markets in such spurious times in value terms

With volatility proving that no asset class is completely safe, many investors are recognising the potential of alternatives like high yield bonds, both as a generator of returns and as a diversifier

With the markets braced for yet another turbulent year, PM takes a look at how the key asset classes might fare

Far from resting on its laurels, Global Investment House is taking full advantage of the market downturn to grow and develop a powerful private equity business in the Gulf region

New balanced funds offer investors access to a wider array of asset classes than ever before, but it’s their single-manager approach that will most appeal to trustees

Times have changed in the institutional world, and equities still rule the roost. But how does currency fit into pension fund portfolios?