March 2024 • Topic: Capital markets • by William Wright & James Thornhill
This short paper highlights the structural shift in the way UK pension funds invest the money they allocate to equities away from their traditional ‘UK centric’ approach to a ‘global equities’ approach. While this shift is self-evident to people working in the industry it is less well known outside of it. It has had a significant impact on the allocation to UK equities and will continue to act as a drag on the UK market for many years to come.
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The dominant narrative in the debate on the decline in the asset allocation by UK pension funds to UK equities over the past few decades has focused on two factors: the relative unattractiveness of the UK stock market, and the shift en masse by private sector defined benefit pensions away from equities as they have matured, de-risked, or closed.
This paper focuses instead on how and why pension schemes have migrated en masse away from their traditional ‘UK centric’ approach (in which they would typically invest 20% to 30% of their assets in UK equities) to a ‘global equities’ approach (in which their investment in UK equities is roughly in line with the UK’s weight in global indices of about 4%, which translates into about 2% of the fund’s total assets).
This shift is self-evident to people working in asset management and pensions, but it is less well known outside of it. While there are plenty of sensible reasons for UK pensions to reduce the domestic bias in their investment, this paper highlights that it has had a significant impact on the allocation to UK equities and will continue to act as a drag on the UK market for many years to come.
This paper is not complaining about this shift or criticising pension funds for making it. It seeks instead to identify the impact of this shift and highlight poor levels of disclosure around asset allocation to better inform the debate on the future of UK pensions and capital markets. Even sensible decisions have consequences….
We analysed the fund-by-fund asset allocation of all 86 local authority pension funds in the £370bn Local Government Pensions Scheme (LGPS) over the past decade and found:
The paper argues that this shift has acted as a mechanical drag on UK equities and has helped create a negative feedback loop of lower demand, lower valuations, and lower demand.
We welcome the government’s proposal for pension funds to publicly disclose their asset allocation to UK assets and to UK equities in a simple, clear, and consistent way (something we specifically recommended to the government a few months ago). We also recommend that official data across UK pensions should be consolidated and improved, and that DC pension providers should explore offering an alternative ‘UK weighted’ default fund with a higher allocation to UK equities, perhaps similar to the asset allocation of Australian superfunds.