What Determines the Asset Allocation of Defined Benefit Pension Funds?

Abstract

The asset allocation decision is one of the most important decisions made by defined benefit pension schemes, with a major effect on the scheme contribution rate, funding ratio and financial position of the sponsoring company. We investigate the determinants of the equity allocation of UK pension funds using a panel of 1,304 observations on 125 companies that were members of the FTSE 100 over the 2003-2019 period. We find that seven variables have a significant effect on the allocation between equities and bonds – maturity (as measured by the effective duration of scheme liabilities), default risk, leverage of the sponsor, size of the sponsor (or the scheme), whether the scheme is closed to future contributions, whether the scheme has significant overseas liabilities, and a time trend. Our sensitivity analysis finds that the biggest effects on the asset allocation come from scheme maturity, the scheme’s funding ratio and a time trend.

Keywords: Defined Benefit Pension Schemes; Pension Fund Asset Allocation; Pension Scheme Maturity; Pension Liabilities; Effective Duration; Risk Management

JEL Classification: G23; G32; J32