In this week's Informed Comment, Jupiter's Charlie Crole and Ian McVeigh ask whether UK schemes' jettisoning of the stock market has gone too far, and which schemes could still benefit.
While DB managers might well acknowledge the superior returns equities can offer over most other asset classes, the need to deliver predictable income streams to meet pension payments have steered them over the past 10 years to the perceived safe haven of the bond market.
If equities have converged to such an extent, there is perhaps less reason for an investor to limit his opportunities
The increase in scheme deficits, coupled with new regulatory and accounting constraints that put a focus on solvency and matching assets to liabilities, has further undermined the case for a more significant allocation to stocks.
Private sector DB pension schemes’ average weighted allocation to UK equities fell to less than 10 per cent for the first time in 2012, a precipitous drop when you consider the average UK funded pension scheme – both private and public sector – held nearly 50 per cent in UK equities as recently as 2000, according to National Association of Pension Fund figures.
To believe the jettisoning of UK equities has gone too far is to hold the view that some pension fund managers continue to operate in the same environment they did 25 years ago.
They do not, and asset allocation trends, far from pointing to renewed interest in UK stocks, suggest if anything that DB managers will continue to scale back their exposure.
Where equities could benefit schemes
Appetite for UK stocks is likely to come from a sector of the pensions market where maximising returns remains the key goal: defined contribution schemes.
These investors will look for investments that are easy to understand and have the ability to provide a good yield
These investors are making up an increasing proportion of the UK pension market as more and more companies close their DB schemes to new employees.
The onus is on DC savers to ensure the investments he or she makes under the DC scheme provide an income that will allow him to live comfortably once he has retired.
They will be quick to realise that the return of 2-3 per cent that government bonds can offer will be insufficient to guarantee the standard of living to which they had grown accustomed.
They will have to look to equity markets for higher returns – to the UK market, for instance, which has, historically, delivered an average long-term return after inflation of 5.2 per cent, or to US equities with a return of 6.2 per cent, on Credit Suisse figures.
These extra percentage points of performance can make all the difference to a saver’s post-work life, especially in an era where people are spending almost as long in retirement as they do in employment.
These investors will look for investments that are easy to understand and have the ability to provide a good yield.
UK-listed companies have some of the most generous dividend-paying policies in the world – a potentially valuable income stream for the yield-starved saver, especially in an environment where gilt yields offer barely a premium over stocks and no inflation-matching potential.
DC investors, however, will only be able to take up some of the slack as research suggests DB schemes will continue to reduce their UK equity holdings.
The NAPF’s 2013 ‘Trends in defined benefit asset allocation’ survey shows the fall in UK equity allocation has been “far more marked” among closed schemes.
In 2012, fully open DB schemes had an average allocation to UK equities of 13 per cent compared with an allocation of 7 per cent for fully closed schemes.
Should DB scheme closures continue at the same pace as in 2012, the NAPF estimates a further £31bn could drop out of UK equities by 2020.
Finally, as markets have internationalised we have seen a significant convergence of risk and return across equities. Most developed equity markets over the past 10 years have delivered similar returns.
The FTSE All-Share TR Index is up over 140 per cent, the FTSE World Europe ex-UK has gained 155 per cent, while the FTSE World Index has risen 132 per cent.
If equities have converged to such an extent, there is perhaps less reason for an investor to limit his opportunities to the UK stock market.
Charlie Crole is institutional director at Jupiter Asset Management and Ian McVeigh is manager of the Jupiter UK Growth Fund
