Home bias to UK equities has cost schemes, say experts

Pension scheme investors across the globe have relied heavily on returns from growth assets such as equities in an effort to stave off the downturn in funding levels caused by the slump in yields. 

According to a survey by research company Create Research, 30 per cent of the 705 institutional investors asked expected pension funds to increase their equity allocations while 65 per cent believe equities will remain attractive in a low-yield environment.

Source: Create Research

Balancing act

Analysis of FTSE 350 pension scheme funding levels by Goldman Sachs Asset Management this week showed the aggregate funding level for the sector had declined 3 per cent during 2014. 

GSAM attributed 14 per cent of the £8.7bn surge in aggregate scheme deficit to the dramatic fall in interest rates during the year.

David Curtis, head of UK institutional business at GSAM, said schemes with fixed income protection had been better protected against the effects of declining yields and lower discount rates.

“[The] focus on risk management is a critical one,” said Curtis.

“Last year shows that if you didn’t implement more hedging in your portfolio you were exposed. 

“Whilst having more equity has been positive, the implication is you’ve had less fixed income and therefore you’ve performed more poorly,” he said.

Home bias

Allocations to equities remained high for FTSE 350 schemes during 2014, but the benefits of a strong year for the asset class were partially offset by an underlying domestic bias.

In 2014, FTSE 350 schemes allocated nearly a third (29 per cent) of their total equity exposure to domestic stocks despite the UK market accounting for only 7 per cent of global market capitalisation.

The UK market returned just 0.7 per cent during the year, lagging behind the MSCI Global Equity Index which ramped up a 10 per cent return over the same period.

I think there’s an evident domestic bias in UK pension schemes and last year it worked against them

David Curtis, GSAM

The combined impact of schemes’ heavy domestic exposure and the relative underperformance of UK equities cost pension schemes’ portfolios around two per cent of performance last year.

Smaller schemes were hit hardest; the equity exposure of those with less than £100m in assets was 15 percentage points higher than schemes larger than £5bn.

Curtis said: “I think there’s an evident domestic bias in UK pension schemes and last year it worked against them.

“It could be to do with perceptions of riskiness, [it] may be possible that pension trustees perceive UK equities as lower risk than global equities, but in this case they’ve actually proven more risky because they’ve underperformed.”

Shamindra Perera, head of UK pensions solutions at asset manager Russell Investments, said smaller schemes tend to work with smaller consultants who have limited resources to fund the extensive manager research required to capture global opportunities.

“[Smaller consultants] will tend to use UK-based managers,” said Perera. “Even for larger consultants who have smaller pension fund clients, their research gets paid for on a time-based fee.”

Perera said schemes’ UK bias was often justified on the basis that UK companies’ global revenues provide underlying diversification. 

But he added: “I’ve heard that argument but it really doesn’t hold any water because UK companies tend to be focused on certain industries.

“If you don’t have sufficient governance resources to implement you might be forced to have a more simple allocation.”

However, Philip Rose, chief investment officer at consultancy Redington, said schemes could access global opportunities cheaply.

He said: “By investing through passive global funds, schemes do not necessarily need a specialist investment team or strong governance to gain exposure to non-UK markets.

“By investing in a diversified manner, schemes can also access developed market equities as cheaply as gaining UK exposure alone.”