- Greater transparency of workplace pension performance announced by the chancellor is welcome, but might achieve the opposite of the desired boost to British business
- Public disclosure of UK exposure alongside performance could lead to funds with high UK exposure being shunned
- The average pension fund invested in UK shares has returned 40.7% over the last 10 years compared to 143.2% from the typical pension fund invested in global shares
- Pension fund managers, trustees and consultants are much more likely to allocate money based on the MSCI World Index than fulfilling the government’s industrial strategy
Laith Khalaf, head of investment analysis at AJ Bell, comments:
“The chancellor’s pension reforms could well backfire on British business. If league tables for pension fund performance were published right now, they would probably show those with high exposure to UK shares languishing near the bottom. The poorly performing schemes the chancellor wants to close to new business could very well be the same ones he wants to champion as exemplary models of investment in UK plc. The average insurance company pension fund investing in UK shares has returned 40.7% over the last 10 years, compared to 143.2% from a more global approach. Put another way, a £10,000 investment in a pension fund investing in just UK equities would now be worth £14,071, compared to £24,319 if invested in a global pension fund.
Source: FE total return to 1 March 2024
“In reality the default funds targeted by the new pension reforms would never invest in just UK equities. But the vast gulf in regional equity performance shows the challenge faced by those schemes who might want to stick their head above the parapet and invest heavily in UK shares. It also highlights the fact that the government’s decision to make pension funds publish their UK exposure as well as their performance might actually result in default fund selectors shunning funds which have bet heavily on UK plc.”
The significance of benchmarking
“Pension fund selectors are already sensitive to investment strategies which deviate too far from peers and global stock market indices. If you’re choosing a pension fund for hundreds, thousands, or possibly tens of thousands of employees, then conventional wisdom is not to take too much risk. That often means sticking pretty closely to the MSCI World Index with the equity side of your default strategy. Unfortunately the UK now only makes up 3.9% of that index, down from around 10% just over a decade ago. If you look at the MSCI World SRI index, which weights stocks according to the ESG credentials that are so important to many pension schemes, the proportion held in the UK is even lower, at 3.5%. These percentages are based just on the equity portfolio of the pension fund, in practice they are also diluted by fixed interest exposure, which in many pension schemes will be in the region of 20% to 40%.
Source: Morningstar, based on iShares MSCI World ETF
“There is something of the chicken and the egg about the performance of the UK stock market and its position in global benchmarks. Capital flows into UK equities would spark better performance, which put upward pressure on the UK weighting in global stock market indices, which would in turn create greater capital flows. The government should have its fingers crossed for some catalyst for a rally in UK stocks that might trigger a virtuous circle. However, good relative returns from the UK in 2022 were not rewarded with an enduring flourish, which suggests any turnaround would need to be sustained for some considerable time to instil enough confidence amongst investors to significantly move the dial in global indices.
“Part of the problem is that global benchmark rankings are not only determined by UK performance, but also the performance of other regions, notably the US, which now makes up over 70% of the MSCI World Index. Two individual US stocks, Apple and Microsoft, each constitute more of the index than the entire UK stock market, and Nvidia is knocking on the door. This underlines the challenge faced by the UK stock market in a globalised investment universe where capital flows are corralled by benchmark indices. To gain market share in global stock market indices, the UK has to nab it off someone else by performing better. The one thing that could potentially save the UK’s blushes is a technology crash which would see the Magnificent Seven cut down to size. That shows no signs of appearing as the melt up in tech stocks continues apace, given fresh momentum by the potential rollout of artificial intelligence systems across the global economy.”
Pension fund disclosure
“The decision to shine a light on pension fund performance is welcome, because it will illuminate a fairly important segment of the wealth enjoyed by UK households which is not currently open to the same level of scrutiny as large investment funds like Fundsmith Equity or Scottish Mortgage investment trust. The idea of performance being compared with funds of the same size rather than a similar risk profile is a bit weird, but presumably this is something which will be ironed out by the FCA consultation.
“The plan to prevent poorly performing schemes taking on new business is pretty interventionist, especially seeing as the additional publication of performance data should assist employers, trustees and consultants to make more informed decisions and vote with their feet if they feel it necessary. In theory this is a market where the fund selectors are informed buyers, representing companies and often taking advice from professional consultants. The government should also give some consideration to the disclosure produced by closed pension funds which are no longer seeking new investment, but which continue to manage large sums of money on behalf of savers. As investors approach retirement, many older schemes invest in annuity hedging funds, some of which fell by 40% as interest rates rose in 2022.
“Overall the publication of pension fund asset splits and performance data should open up the potential for comparison and analysis which should help trustees, consultants, employers and investors make more informed decisions when selecting a fund. But it may also lead them away from, not towards, investing in UK shares.”
