UK Pension Funds posted a negative return of almost 13 per cent in the third quarter, according to initial estimates from The WM Company – which this week learned it will become part of State Street. The out-turn for the year to the beginning of the fourth quarter is a negative 17 per cent.
“These results are severe and pose a number of problems for asset managers, trustees and fund owners. However, it is important to put these figures into context,” says Eric Lambert, WM executive director. “Many asset managers are saying that the equity markets as a whole now represent fair value and that it is possible to buy good companies at reasonable prices. The equity market weakness has required some institutional investors, such as Life companies, to move out of equities into bonds for reasons of solvency. Recent performance might similarly increase pressure on pension fund trustees to switch from equities to bonds in an effort to reduce risk, but this could be a very poor time to switch. History shows that upturns in equities can be every bit as dramatic and unpredictable as downturns. Also it is possible that inflation will revive and bond prices will slide. For long term investors such as pension funds a sound strategy is to buy and hold equities, as an asset class, rather than attempt market timing.
Some relief has been provided by the strong performance of defensive assets such as bonds and property. Property is the forgotten asset, but it has held up well, returning about 6 per cent in the nine months to 30 September.
Property was the original alternative investment and has provided excellent diversification. These figures show the financial risks to sponsoring employers continuing to offer a Defined Benefits scheme. On the other hand employees, and their Trade Union representatives, are finally realising the value of a Defined Benefits pension scheme as part of their overall compensation package. However for people retiring from a Defined Contribution scheme, the current environment is bleak. They face the double whammy of having a fund that will have shrunk by about 11 per cent in the last year and having to buy expensive annuities on low gilt yields. Looking over the longer term, funds have been progressively reducing their exposure to equities. In 1993 the average fund had over 80% in equities, and there has been a gradual reduction to the current figure of 62%. Within this decreasing equity exposure, the overseas component has been rising steadily.
The US, as the dominant global equity market, has benefited most from this move to greater internationalisation. We have seen the major equity markets in the US, Europe and the UK move in tandem throughout the current bear market. According to the theory of international equity diversification you expect a fall in one market being offset by a rise in another. This has not happened, major markets have moved in a synchronised way, providing evidence that not all investment theories work in practice.”