Funds’ equity commitments hit a peak
Pension schemes’ allocation to equities has peaked at a worldwide average of 56%, and is set to go into decline, according to a prediction from the investment advisers Watson Wyatt.
The increasing maturity of many defined benefit funds – often closed to new members in countries such as the UK and USA, which make up a sizeable chunk of global pension assets – is one reason for the shift. It means billions could be pulled out of stock markets over the coming years.
The other main reason for the shift, according to Tim Hodgson, senior investment consultant, is that pension funds are increasingly looking at investments other than bonds or equities.
The average global allocation to these so-called alternatives, which include investments like private equity or commodities, stood at 11% at the end of last year, up from 7% in 1996.
Setting out the findings of the consultancy’s “Defining Moments” research project in London yesterday, Hodgson said the industry faced two main challenges.
The first is an increased risk of financial crises, thanks to contagion caused by the interconnectivity of capital markets. The credit crunch that began last summer is an example of this, he said.
The second is a misalignment of incentives within the financial services industry itself.
Hodgson said: “We have a skewed incentive structure, with asymmetric information. The professionals know more than the owners and are incentivised to keep it that way.
“Economics 101 would suggest that competition is a good thing, and will drive down costs. That doesn’t seem to work in the investment space. There is massive competition for alpha [outperformance over market returns] but no-one is lowering their fees.”
Watson Wyatt estimates that pension funds’ costs have risen by about 50% in the past five years, from about 0.65% of their assets, to about 1.1%.
Hodgson also suggested that another challenge faced by the industry is the provision of adequate defined contribution pension models, in which the scheme member takes the risk that investments will not perform.
These schemes are gradually replacing the older defined benefit model, in which the sponsoring employer has to bear this risk because commitments must be met.
He said: “Contributions to DC funds are not high enough, and the costs in the system are too high. The key is auto-enrolment and very very good default funds.”
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