An upside of higher rates for pension schemes is a reduction in the value of future liabilities. Many defined benefit (DB) pensions in Europe are taking advantage of this to derisk portfolios by locking-in higher-yielding, public investment grade fixed income assets, according to Nuveen's 2024 EQuilibrium survey. This is freeing them up to explore more private investments and, in some instances, these investments are also playing into schemes' environmental and social objectives.
A new interest rate regime
Post-pandemic inflation triggered a steady increase in base rates in many European economies. They began edging higher in late 2021 in the U.K. and summer 2022 in the eurozone, having been anchored at ultra-low and even negative levels since the global financial crisis in 2008.
The Bank of England and the European Central Bank's base rates reached peaks of 4.5% and 5.25% respectively between the second half of 2023 and the summer months of 2024. While rates have been cut, they are expected to remain at elevated levels. More than 80% of pension investors in Europe agreed that we are in a higher-for-longer rate environment in our survey.
With higher base rates equating to a higher discount rate, the funding position of many DB pension schemes has improved. Responding to this, alongside regulatory changes to facilitate alternative investing in some countries, we're seeing pension schemes pursuing a range of private asset classes that offer higher yields and long-term cash flows.
The following section highlights four of these investment themes, several of which also serve environmental and social goals.
Infrastructure debt
Over 40% of German pensions and U.K. public pensions are planning to increase allocations to private infrastructure. This isn't surprising given the capital needed to transition economies to lower carbon energy sources. According to McKinsey, $275 trillion in cumulative spending on physical assets is needed through to 2050.
Many countries are looking to decarbonise their energy generation and transmission, electrify transportation and encourage renewables such as wind and solar power. Providing debt financing for these infrastructure projects has the potential to align with net zero commitments and portfolio decarbonisation plans, while also providing a stable income stream and diversification.
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