Sir Nigel says that pension funds are increasingly pulling back from stocks and investing instead in safer but less lucrative assets such as bonds, in a growing problem known as de-equitisation.
Figures released earlier this year by the think tank New Financial showed that 53pc of pension funds’ total assets were invested in UK stocks in 1997, but this had plunged to just 6pc in 2021 as money was shifted elsewhere.
As a result, British pension funds and insurance companies now own just 4pc of the stock market, down from 39pc in 2000. The trend risks undermining the economy while also leading to lower returns for workers saving into pension funds.
What’s really happened is that the “pension funds” have closed to new entrants. Most of those private sector defined benefit funds are now in run off. They’re feeding pensions to retirees, not saving money up for the next generation of them. Sure, there have also been G Brown’s idiot changes and so on. But funds in run off should – perhaps – be in bonds not equities.
The other factor is that UK pension funds have become less parochial about their equity holdings over the period.
They used to have a far higher share of their total equity holdings in UK equities than would be suggested by the share of the UK in world market capitalisation. That is much less true now.
Other countries’ pension funds have evolved in the same way, and the result is that a higher proportion of the UK market is now owned by US, Dutch, Australian etc pension funds than used to be the case.
“Perhaps” is doing a fair amount of lifting, there.
The assumption post-ERM Crisis, was that BoE independence (already targeting inflation instead of asset prices anyway) would maintain a steady rate of inflation a la the Bundesbank. That would, possibly, be fine and dandy.
By amazing fortune, Amazon and China happened, so inflation was further suppressed by mechanisms entirely beyond the control the CBs, whether “independent” or not.
So inflation risk to fixed income holdings was low. Great.
In theory, the pension funds would have been better off by holding equities for the dividend yield, but the likes of Microsoft didn’t pay divis for quite some time after listing. The Tech Booms panned out to follow that model, since they didn’t have any bloody revenue, only farcical valuations based upon previous funding rounds.
Equities are volatile in the short-/medium-term; they provide better returns than fixed interest over almost every period of twenty years or more.
Pension funds whose DB section closed to new members 10-20 years ago still have members who should be expected to be drawing pensions in 50-70 years’ time.
So they should have a significant portion of their investment in equities to fund these very long-term obligations.
BUT the rules about pension deficits and surpluses are unbalanced. If there is a deficit when the actuarial valuation is carried out the trustees are required to agree with the sponsoring company a means to eliminate the deficit which almost inevitably means the sponsoring company coughing up several £million extra; if there is a surplus, it’s very difficult for them to give any money back to the sponsoring company. So, unless the company’s FD actually understands this stuff and is willing to explain it to shareholders and investment analysts wotking for hedge funds he has an incentive to tell the Trustees to make “safe” investments in gilts and A-rated bonds. In the long run it will cost more 99% of the time but “nobody got fired for choosing IBM”
John77 is right on his own account but lots of pension schemes are now “fully funded” at current rates and what to dump their liabilities on insurers as quickly as possibly. That way the FD doesn’t care about equities or credit and can focus on running the company balance sheet.
Red herrings abound.
There’s a £20bn pension transfer knocking around now. That one scheme is bigger than the empire transfer market a few years ago and is 1% of (non state) DB liabilities on its own. Keep an eye on the press. L&G and a coupe of others are prepositioning for this.
Would this pan out like Resolution?
“But funds in run off should – perhaps – be in bonds not equities.”
Up to a point. If a fund is in run off then it doesn’t need to worry too much about capital value, but about cash flows, so the volatility in share prices is not a problem and dividend yields are somewhat insulated from earnings volatility.
Closing the DB schemes was the problem. Without that cataclysm, the growth asset class that is equities would have continued to be the natural asset class to hold into perpetuity.
@ David Boycott
Actually it does need to worry about capital values as part of its cash inflow comes from selling investments as its assets and liabilities shrink in tandem