European pension funds say reducing absolute portfolio volatility is their top risk management priority, as geopolitical tensions and high inflation continue to impact global investment markets.

This is according to new research [1] from Alpha Real Capital (“Alpha”), the specialist manager of secure income real assets.

Nearly half (46%) of European pension fund professionals interviewed, who collectively manage €324 billion in assets under management, say increasing portfolio diversification is their top strategic asset allocation priority. Meanwhile, more than a quarter (28%) of respondents say their priority is to increase expected returns; and 18% will target increasing portfolio income.

Inflation risk

Annual inflation in the euro area rocketed to an estimated 9.8% in July 2022, up from 2.2% last July. (2) . In response, the European Central Bank raised interest rates for the first time in 11 years by 0.5% in July 2022 and is widely expected to continue raising rates in a bid to combat inflation.

European pension funds are concerned about high inflation – with only 7% of respondents saying they were not worried about inflation. This is understandable given over 70% of survey respondents claiming to manage their assets to an inflation plus benchmark (88% are looking to beat their strategic benchmarks by 1% to 3% over the long-term). Interestingly, 56% of respondents hedge less than 50% of liability inflation risks while 20% do not hedge liability inflation risks at all. Just over one-fifth (22%) are looking to increase inflation hedging.

Colin Frearson, Client Solutions Director Alpha Real Capital said: “Rising inflation is a real threat for European pension funds unless they have taken steps to hedge their exposure. Investing in real assets that include inflation linked returns – such as infrastructure and commercial real estate – can be a powerful way to help mitigate against the risk of rapid price increases that we are experiencing in the current environment.”

Phillip Rose, CEO Alpha Real Capital said: “Ongoing geopolitical tensions make for unpredictable markets and have contributed to an inflation surge. It makes sense that European pension funds’ top strategic priority is to diversify portfolios and include non-correlated assets. Investing in real assets with secure income flows that do not respond in the same way as traditional assets such as equities and bonds, can help keep volatility under control while simultaneously delivering strong inflation linkage. For example, Alpha’s secure income real estate investments have shown exceptionally low volatility over the last 12 months while delivering reliable income with annual inflation-linked increases.”