UK Pension Funds Shift Assets Out Of Domestic Equity, Says Greenwich

UK pension funds are less invested in domestic equity in 2002 than they were in 2001, as the market continues to shift in response both to lower equity prices and to recommendations put forward by the Myners Review. Or so

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UK pension funds are less invested in domestic equity in 2002 than they were in 2001, as the market continues to shift in response both to lower equity prices and to recommendations put forward by the Myners Review. Or so says a recent study by Greenwich Associates.

“Winds of changes continue to sweep through the British pension community, and flexibility remains a vital asset for fund officials,” says Greenwich Associates consultant Rodger Smith.

Most notable is a move out of domestic equity, where the percentage of total fund assets invested in domestic equity slipped from 47% in 2001 to 43% in 2002. The proportion had been as high as 49% in 2000. Domestic equity investment remains higher in the United Kingdom than in most of the world’s other major markets, which has historically been the case.

Funds are moving assets more into fixed interest. According to Greenwich Associates findings, 23% of total assets are invested this way, up from 21% in 2001 and 19% in 2000. Fund expectations shared with Greenwich Associates indicate these trends will continue.

“These allocation shifts can be seen as a dynamic response to the relative volatility and underperformance of the equity markets,” consultant Chris McNickle notes. “On the one hand, funds are trying to preserve capital. On the other, they are seeking higher returns through other asset classes such as international investmentsor property, even alternative investments to an extent.”

The trend toward asset diversification is accompanied by a dramatic increase in the use of specialty managers. Over the past five years, use of specialty managers more than doubled, from 41% in 1998 to 89% in 2002. The share of total assets managed by specialty managers has grown to 74%, from 27% just three years ago.

Greenwich Associates research also reveals the average number of managers employed by a fund has grown, from two or three just five years ago to 4.2 now. That number is expected to climb as well.

Greenwich Associates applauds this trend, but with a caveat. “As funds seek to achieve diversification and increase value-added returns through broader asset allocation and specialty manager selection, fund professionals need to keep in mind that the incremental addition of managers adds complexity, increases demands on internal staff and trustees, and raises fees,” consultant John Webster cautions.

Another area where structural change is evident is in the continued rise in use of defined contribution (DC) plans. Nearly half of all U.K. corporations now offer DC plans, up from one-third just two years ago.

“While the proportion of assets in these plans is still small at 7%, it is projected to triple to 21% in the next ten years” consultant Chris McNickle notes.

One of the biggest prompters of comment and concern among U.K. fund officials this year was the new accounting standard FRS 17, which requires funds to match liabilities with assets every year in their financial statements to avoid shortfalls. 19% of funds named FRS 17 the biggest single factor influencing their strategy, and twice as many funds consider it a major issue than say it will have little or no effect on their plan.

“Marking assets and liabilities to market every year can obviously include fairly significant balance-sheet swings,” John Webster says. “If you’ve got a lot of volatility in your asset mix, what people are suggesting is you need to take some of that out, specifically by broadening diversification and moving away from equities.”

Salaries continued to rise for U.K. fund professionals in 2002, up more than 5% from an average of 57,200 to 60,300. The average bonus awarded for 2001 was 10,700 and 40% of all U.K. fund professionals are now bonus eligible.

There are some significant variances by type and size of fund, however. Fund officials at local authorities, while receiving more modest increases, are still paid significantly less than other pension professionals, and just 3% are bonus eligible. Fund professionals at corporate funds and at the largest funds are the most highly compensated, and most likely to receive bonuses.

In April and May of 2002, Greenwich Associates conducted interviews with 390 professionals at the largest tax-exempt funds in the United Kingdom. Institutions included corporate pension funds, local authority funds, and U.K. subsidiaries of foreign corporations. Interview topics included asset allocation, structure of investments, use of DC plans, hiring and termination of managers, and compensation.