THE CHANGING ECOSYSTEM
OF DEFINED BENEFITPENSIONSVOLUME 3 – AUTUMN/WINTER 2023

russellinvestments.com/dbresearchForeword
In the autumn of 2022, the pensions world was rocked by the UK Government’s autumn statement
announcement. A huge crisis in the UK gilt market followed. Many schemes were under pressure toadjust their portfolios, resulting in significant selloffs of assets to create sufficient collateral and liquidity to
manage the crisis.
Just over twelve months later, pension schemes find themselves in a very different position. Many haveseen their endgame prospects improve. Rises in interest rates and yields have had a substantial impact
on funding levels. As a result, most schemes are much better placed, with some considering endgame
within a much shorter time horizon than envisaged 18 months ago.
While positive, this also leaves pension schemes and their decision-makers with much to reflect on.
Important decisions need to be made if they are to navigate new circumstances successfully. It is in thiscontext that we present the findings of Russell Investments’ third UK Defined Benefit Markets Insights
study, where we survey senior personnel within the pensions world to understand their expectations,priorities and concerns.
We hope you find the insights from our study useful, and we welcome further discussion into the detailsof this report and its conclusions.

Simon Partridge
Head of UK Fiduciary Management

Russell Investments / The changing ecosystem of defined benefit pensions – Volume 3/1

Contents
Key findings

3

Improved funding levels accelerate focus on derisking and endgame

4

Liability hedging expected to stay at current levels or increase8

Challenges arise as schemes seek to address portfolio liquidity

9

Fears over inflation reduce, but schemes question insurance market capacity

10

Changing priorities and action on ESG

11

Focus Group: Regulatory pressures and operational considerations
prompt new approaches to governance

12

Summary

13

Russell Investments / The changing ecosystem of defined benefit pensions – Volume 3/2

Key findings
Improvements in funding levels resulting from market conditions have resulted in a significant
number of schemes accelerating their plans focusing on endgame. Almost one-third (30%)
indicate that they are now working towards endgame within a shorter timeframe.

This change in timeframes is impacting asset allocation decisions. Schemes are prioritising
increases in liquidity to make portfolios as attractive as possible for insurers so thatthese schemes can move to buyout. However, this raises some challenges in how schemes
reduce exposure to illiquid assets such as private equity without having to accept discounts.

The capacity of the buyout market is a concern for pension schemes. One-fifth of
respondents identify this as a significant risk.

While ESG remains an important consideration for many pension schemes (specifically theissue of climate change), decision-makers recognise the implications of changing asset
allocations. Specifically, the move away from equities and illiquid assets to bonds andcash is impacting schemes’ ability to effect long-term tangible ESG action.

Regulatory volume remains a key challenge for many schemes. Combined with practicaloperational pressures as schemes seek to position themselves for endgame, some are looking
at moving to a sole trustee model to ensure sufficient access to specialist expertise to manage
these demands.

Survey methodology
The Russell Investments UK Defined Benefit Market Insights is based on the responses of 107 UK defined benefit schemes
between September and October 2023. Those participating in the study are responsible for over £250 billion of assets undermanagement in total. Respondents included scheme CEOs, CIOs, professional, company- and member-nominated trustees, andpension managers. Responses were collected via an online survey conducted by SurveyMonkey, with support from the Pensionsand Lifetime Savings Association (PLSA).
To supplement our insights, Russell Investments undertook detailed interviews with a focus group of 12 leading professional andindependent trustees to assess their views on a range of key topics. Comments from these respondents are included in this reporton an unattributed basis. We would like to thank those individuals interviewed for their time and insights.

More than £5 billion
17%

Less than £100 million
12%£100 million - £500 million
20%£1 billion - £5 billion
32%£500 million - £1 billion
19%

Source: Russell Investments, November 2023.

Russell Investments / The changing ecosystem of defined benefit pensions – Volume 3/3

Improved funding levels accelerate focus on derisking and endgame
Despite the challenges arising from the UK government’s autumn statement debacle in 2022, in many cases pension schemes findthemselves in a much-improved position than might have been anticipated at the start of that year. Funding levels have improved,
resulting in some schemes beginning to consider endgame solutions within a much shorter time horizon than previously
anticipated.
While the majority (52%) of respondents indicate that their time horizons towards endgame have not changed, almost one-third(30%) suggest they are now operating on a shorter timeframe – in some cases looking at this as an immediate priority. 11% ofschemes are now considering a longer timeframe to endgame, suggesting a shift in objective towards a run-off or low-dependence
strategy.
Interestingly, only a small proportion have changed their target, as noted in the Focus Group comments to the right. However, noclear pattern has emerged from this small sample: schemes have varyingly moved to target buyout, low-dependency run-off orpension scheme consolidation.

Exhibit 1: Changes in endgame timeframe
Focus Group Quotes

Change intarget5%

No response
2%

Longertimeframe
11%“Those that had little or no LDI
in place did really well and arelooking at being fully funded.
Some have accelerated theirderisking process by probably
10 or 15 years.”“Schemes have largely beenin two camps. Those that havebeen well-governed haveprobably come out of it [LDI] ina more difficult position [due tohigher levels of hedging].”

Shorter
timeframe30%

No change
52%

Source: Russell Investments, November 2023.

Russell Investments / The changing ecosystem of defined benefit pensions – Volume 3“The majority of schemes
have seen an improvement infunding levels and areprobably ahead of where theywould expect to be. There's
probably a bit of irony that theschemes that were quite
unhedged have reallybenefitted.”“Objectives are still similar, but
timeframes have moved.
There have been quite a few
operational aspects toconsider, but so far, it's only
timeframes that havechanged.”/4

Looking at endgame time horizons, there are small differences depending on scheme size. The majority of schemes are still at
least four years away from their endgame, with over a third looking at timeframes of more than seven years.
However it is interesting to note that nearly a quarter of all schemes expect to reach their endgame objective broadly within thenext valuation cycle (1-3 years), while 13% of smaller schemes surveyed have already reached their endgame target.

Exhibit 2: Expected timeframe to endgame
40%

37%
33%

35%

33%

29%

30%
25%

25%

22%

20%
15%

13%

10%
3%

5%

5%

0%

0%

Already achieved

1-3 years

4-6 years

Less than £1bn of assets

7+ years

No response

More than £1bn of assets

Source: Russell Investments, November 2023.

In spite of the accelerated endgame time horizon, many schemes are still to finalise their plans and thinking. While buyout is themost popular choice for schemes, over one-third (35%) are still to decide on their ultimate endgame objective.

Exhibit 3: Endgame objective
No response3%
Buyout38%

Focus Group Quotes“It's been drummed into
everybody that the gold
standard is going into theinsurance market. Are there
structural risks that are
created by having everybody
in the same type ofapproach?”Not decided
35%

Low dependency
runoff21%

Consolidator
3%“I would advocate that all
trustees take a pause and lookat whether (going into theinsurance market) is actually
the best thing for the scheme
members.”

Source: Russell Investments, November 2023.

Russell Investments / The changing ecosystem of defined benefit pensions – Volume 3/5

The improved circumstances of pension schemes are reflected in their shifting priorities. Improving and maintaining funding levels(56%) and derisking towards endgame (also 56%) remain the primary focus for decision-makers. Of almost equal importance ismanaging market risk (53%) and improving sustainability (50%).
Reducing pressure on sponsors (30%) is increasing in priority as is leverage and collateral (27%), while accessing new asset
classes (7%) is seen as low priority by almost all respondents, reflecting the leap forward in funding positions and focus onderisking.

Exhibit 5: Current respondent investment priorities
70%

60%

62%
60%
56%

56% 56%

58%
55%

54%
53%

50%

50%
45%

43%

40%

30%
27%

30%

21%

27%
21%

24%
23%

26%
23% 22% 22%
22%
21%

28%
26%
21%

20%
13%
9%

10%

7%

Autumn / Winter 2022

Spring / Summer 2023

Accessing new asset classes

Increasing levels of return

Improving diversification

Cashflow generation

Increasing liquidity

Leverage and collateral

Reducing pressure on sponsor

Improving sustainability / ESG

Managing market risk

Derisking towards endgame

Improving / maintaining funding levels

0%Autumn / Winter 2023

Source: Russell Investments, November 2023.

Russell Investments / The changing ecosystem of defined benefit pensions – Volume 3/6

Further trends arise when priorities are assessed based on the size of scheme. In addition to the same key priorities noted above,
larger entities (those with more than £1 billion of assets) are more focused on leverage and collateral, increasing liquidity andimproving diversification than their smaller peers.

Exhibit 6: Current respondent investment priorities by size of scheme
70%
63%

62%

60%

60%
53%
50%

49%

52%
49%

47%

40%

37%
31%
29%

30%

31%

29%

27%
24%
19%

20%

19% 18%

16%

18%

10%

7% 8%

Less than £1bn of assets

Accessing new asset classes

Leverage and collateral

Improving diversification

Increasing liquidity

Increasing levels of return

Cashflow generation

Reducing pressure on sponsor

Managing market risk

Improving sustainability / ESG

Derisking towards endgame

Improving / maintaining funding levels

0%More than £1bn of assets

Source: Russell Investments, November 2023.

Russell Investments / The changing ecosystem of defined benefit pensions – Volume 3/7

Liability hedging expected to stay at current levels or increase
As noted by one respondent: “I think the first step is trying to continue to manage the risk and not lose the gains that have beenachieved.” This can be seen in schemes’ future plans when it comes to anticipated changes in liability hedge ratios. The majority(68%) of respondents expect their hedge ratio to remain the same, while almost one-quarter (23%) expect to have a higher hedge
ratio over the next two years. Just 9% of respondents expect it to be lower. The priorities of pension schemes therefore appear
clear, with a definite focus on protecting the improved positions that many have found themselves in.

Exhibit 7: Expected changes in hedge ratio in next two years

Expect a higher hedge ratio
23%

Expect a lower hedge ratio
9%

Likely to stay the same
68%

Source: Russell Investments, November 2023.

Exhibit 8: Expected changes in hedge ratio in next two years
80%

73%
68%

70%
60%

53%

50%
40%
30%

25%

23%

23%

20%

13%
9%

10%

9%

4%
0%

0%
Expect a higher hedge ratio

Expect a lower hedge ratio

Autumn/Winter 2022

Likely to stay the same

Spring/Summer 2023

0%

No response

Autumn/Winter 2023

Source: Russell Investments, November 2023.

Russell Investments / The changing ecosystem of defined benefit pensions – Volume 3/8

Challenges arise as schemes seek to address portfolio liquidity
The acceleration of many schemes’ journeys towards endgame is reflected in asset allocations. Planned increases and decreases
in exposures illustrate a focus on reducing risk and improving liquidity.
This is reflected in a significant acceleration in allocations to fixed income assets. Appetite for both government bonds andinvestment grade credit have increased substantially as schemes seek to derisk.

Exhibit 9: Expected increases to asset allocation exposures in the next six months

Government bonds

25%
24%

Investment grade credit

25%
23%

Private credit

9%

Infrastructure

8%

Private equity

8%
0%

5%

Autumn / Winter 2022

35%

31%

12%
14%
16%
12%
12%
12%

10%

15%

20%

Spring / Summer 2023

25%

30%

35%

Autumn / Winter 2023

Source: Russell Investments, November 2023.

Most notably negatively impacted are exposures to property and listed market equities. There is a marked increase in schemeplans to reduce allocations to property compared to previous UK defined benefit market studies.

Exhibit 10: Expected decreases to asset allocation exposures in the next six months
17%

Property

Developed market equities

17%

12%
10%

Private equity

20%

Focus Group Quotes

30%
32%

20%

16%

12%
10%
13%

Emerging market equities

7%
6%

Private credit
0%
Autumn / Winter 2022

5%

10%

12%
15%

Spring / Summer 2023

20%

25%

30%

35%

Autumn / Winter 2023

“Generally, people are looking
for the best way to get out [ofilliquids] and decide when thebest time is to do so. There
are issues like property funds
being gated and durations to
consider. Some schemes arequestioning whether to go to
the secondary market now
and take a discount.”“Some schemes are taking
more of a piecemeal approachrather than putting all theireggs in one basket; going to
the secondary market andtaking a 20% haircut
straightaway.”

Source: Russell Investments, November 2023.

Russell Investments / The changing ecosystem of defined benefit pensions – Volume 3/9Appetite towards other parts of the private markets space remains mixed, with some schemes indicating plans to increase
allocations whilst others intend to reduce their exposure. Typically, the desire to reduce these allocations comes from larger
schemes, with those with more than £1 billion of assets showing greater appetite to reduce private equity (19%) and private credit(14%) exposures. This potentially indicates some differences in the maturity of these schemes, with larger entities being better
funded and therefore better placed to consider endgame options sooner.
Pension schemes are, however, beginning to experience some challenges. Respondents note a concerted effort by many
schemes to reduce their exposure to illiquid assets in order make themselves more attractive propositions for insurers andincrease their ability to move to buyout. As one respondent noted: “I think the smaller [schemes] are [recognising that] insurers justwant cash. So, it's about being liquid but also moving in a similar way to insurer [pricing].”
The number of schemes seeking to take such action raises questions about the capacity within the secondary market for private
assets. One independent trustee interviewed for this study went as far as to suggest that “There’s not really a secondary market
for a lot of these closed end illiquid assets”. Some schemes may therefore be in the unenviable position of having to accept
significant discounts on the price of their assets to move to endgame within their desired timeframe.
This feedback aligns with Russell Investments’ experience over the past 12 months where a number of clients have looked todispose of their private market assets. Despite the challenges faced by some investors we managed to negotiate sales at only
minimum (if any) discounts to Net Asset Value.

Fears over inflation reduce but schemes question insurance market capacity
Concerns over inflation and central bank action have reduced markedly in the last six months. Respondents appear to havegreater confidence that efforts to reduce inflation are beginning to have an impact (a consideration borne out by October 2023
figures which recorded the lowest inflation levels in two years). Similar sentiments can also be seen with respect to the possibilityof recession, indicating greater optimism for either a ‘soft’ landing or possibly even complete avoidance of a recessionary scenario.
We do note that figures indicating diminishing concerns over geopolitical conflict do not incorporate the recent conflict in Gaza,with this study largely completed before the tragic events of recent weeks. Whether this impacts asset owners’ thinking in the longterm remains to be seen. However, at this stage the market reaction to events in the Middle East has been muted. To that end,
reducing concerns over potential geopolitical conflict can largely be attributed to the stalemate between Russia and Ukraine in
Eastern Europe and less pronounced worries over the influence of China on the world stage.

Exhibit 11: Key concerns for pension schemes in the next six months
80%
70%

74%
71%
58%

60%
48%

50%

54%

51%
45%

40%

33%
33%
27% 27% 27%

30%

28%
25%

20%

33%
20%

33%

25%
19%

22%

23%
16%

10%

23%

20%

15%

17%

10%

5%

Autumn / Winter 2022

Spring / Summer 2023

Reporting requirements

Access to buyout providers

Actuarial valuation discussions

Fees and transparency

Collateral management

Climate change

Regulation

Recession

Liquidity management

Market selloffs and volatility

Geopolitical conflict

Inflation and central bank policies

0%Autumn / Winter 2023

Source: Russell Investments, November 2023. Note we added the last three options for the first time in this year’s survey.

Russell Investments / The changing ecosystem of defined benefit pensions – Volume 3/ 10

However, unease is beginning to arise elsewhere, with decision-makers identifying
the demands of reporting requirements and actuarial valuations as sources forpotential concern.
A further area of consideration for pension scheme decision-makers is the ability of
the insurance market to meet the significant and growing demands for buyout
solutions. The shortening of endgame time horizons raises questions about thecapacity of insurers and what pension schemes need to do to make themselves attractive
to buyout providers.
Respondents to interviews for this study, in addition to highlighting issues aroundasset allocation and liquidity, noted the critical importance of governance meeting
requirements such as GMP equalisation, and data cleansing. The consensus among
respondents is that insurers will become increasingly selective and will only accept
schemes that have addressed all these issues and are considered the best prospects.

Focus Group Quotes"We see two barriers. One is
general capacity in the insurance
market. The other is getting theschemes, the data, the liabilities
etc. into a position that an insurer
would be willing to work with.”“Insurers now can be incredibly
picky and can pick and choose
who they want to partner with togo through the buy-in exercise
leading to buyout.”

Changing priorities and action on ESG
ESG remains an important consideration for schemes, with half of respondents (see Exhibit 5) continuing to identify this as apriority. Climate change continues to dominate thinking; most respondents (58% total) indicate they are ‘likely’ or ‘very likely’ toincrease their focus here in the next twelve months. That said, over a quarter still view it as unlikely or very unlikely they will focus
on climate change – perhaps because they have already looked at this, it’s not a priority for them or because their timeframesmean their main focus is elsewhere.

Exhibit 12: Expected focus on climate change in the next twelve months
60%

55%

“I think [ESG] is just as
important for the growthelement, but there’s slightly
less time spent on it. There’s notime to do it in the fixed income
space.”

50%
38%
36%

40%
30%
20%

25%

23%
20%

25%
20%

16%
14%

13%
10%

6%

5%

2% 2%

0%
Very likely

LikelyAutumn / Winter 2022

Focus Group Quotes

UnsureSpring / Summer 2023

Unlikely

Very unlikely“Whilst there might be
grandiose ideas of ESG, you
might only be holding an asset
for 12 or 18 months. Therefore,
there's a question as to how
impactful you could be in termsof voting and other engagement
over quite a short time horizon.”Autumn / Winter 2023

Source: Russell Investments, November 2023.

Russell Investments / The changing ecosystem of defined benefit pensions – Volume 3/ 11

In our previous surveys, nearly half of respondents had yet to decide on their net zero targets. This has decreased this time aroundto less than a third, but the proportion who have decided not to set a target has increased to 15% from 8% earlier this year. Those
who have set a net zero target increasingly aim for 2050 (30% vs. 21% previously).

Exhibit 13: Pension scheme net zero targets

We are not setting a
net zero emissions
target
15%

2030
10%

2040
13%

Still to be decided
32%
2050
30%

Source: Russell Investments, November 2023.

A notable challenge identified by pension schemes is how to practically approach ESG issues amidst the acceleration towards
endgame. The move away from assets like equities, which are typically considered to be more suitable for ESG-related action, infavour of fixed income, has created limitations to what schemes feel they can achieve from an ESG standpoint. These accelerated
timelines also mean that schemes are likely to hold assets for a shorter period, thereby potentially limiting the extent to which they
can have any sort of long-term meaningful impact.

Focus Group: Regulatory pressures and operational
considerations prompt new approaches to governance
While improvements in funding levels and endgame timelines are positive, schemes recognisethese also bring challenges.
Most notable among these pressures are the ones on scheme governance models. This
includes endgame preparation, with the need to make asset allocations and operational
structures attractive to insurers, as well as cater for regulation and dwindling resources.
The issue of regulatory pressures was emphasised by a focus group of independent trustees
interviewed for this study. 58% of respondents expressed frustration with excessive regulation,highlighting the need for pragmatism in legislation given the demands being placed onschemes. Schemes at the smaller end of the spectrum were seen as being particularly affected.
Respondents also noted challenges in retaining experienced resources to manage the various
operational requirements schemes face. Difficulties are emerging in attracting and keeping
talent given the demands on trustees’ time. The limited attraction of working within the defined
benefit market as schemes close and career options become more limited was also cited.
In line with recent trends to outsource investment management to a fiduciary manager,
several interviewees highlighted movements to sole trustee models, where sponsors delegate
responsibility for pension scheme governance to a professional trustee. There is a general
expectation that this model will become more prevalent in the UK pensions market, as bothschemes and sponsors seek to improve efficiencies and enhance governance structures tomeet the demands arising from the proximity to endgame.

Russell Investments / The changing ecosystem of defined benefit pensions – Volume 3

Focus Group Quotes“We’re seeing more schemes
move to a sole trustee model.
In part this has been triggeredby events like the gilts crisis.
Trustees that had to sign
documents in the middle of thenight just feel it isn’t worth it!”“One of the issues on theagenda that's very frustrating,and I'm sure all trustees will
share, is regulation. You haveto look at the DB funding codeand think ‘are we really still
doing this?’”“A bit more legal pragmatismis needed on things like GMP
equalisation. There is a need
to be cognisant of the costburden for small schemes.”/ 12

Summary
Broadly speaking, UK defined benefit pension schemes report material funding improvements over the last 12-18 months. Better
than anticipated positions are leading many schemes to consider endgame scenarios as a realistic near-term objective.
As a result, pension schemes are focused on protecting their improved positions as they begin (or accelerate) preparations forendgame – which, for the time being at least, is still to target a buyout.
While positive, these significant changes to the pensions landscape are bringing new issues for schemes and their advisers. The
need to reduce portfolio risk, improve liquidity, enhance governance activities, and address the necessary regulatory requirements
to appeal to prospective insurers, pose notable challenges that schemes need to address.
The defined benefit space will need to evolve to reflect this new environment. Pension schemes will have to consider all theiractivities in totality – investment, operational, and governance – if they are to build on the progress over the past year and meettheir long-term objectives.

.

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Russell Investments / The changing ecosystem of defined benefit pensions – Volume 3/ 13

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