Should Pension Funds Invest More In Equities?

This article was prompted by an item in Investors Chronicle entitled “Should pension funds be used to prop up UK markets? I think the simple answer is NO. But apparently City Minister Andrew Griffith said at a conference that “the Chancellor is spending a lot of time looking at how we can better unlock the billions of pounds held in UK pension schemes”.

Certainly one major concern is that the share of the stock market now owned by pension funds and insurance companies has fallen in the last 25 years from 53% to 6%.

Before the last war, pension funds invested almost exclusively in fixed income bonds and shares. But in the 1950s and 60s this situation was reversed as high inflation made fixed income securities less attractive. George Henry Ross Goobey, pension manager of the Imperial Tobacco pension fund, was one of the leaders of this revolution.  In 1955, Ross Goobey persuaded the trustees of Imperial Tobacco’s defined-benefit pension fund, one of the largest pension funds in the U.K., to adopt an idiosyncratic investment policy investing exclusively in equities. Due to the subsequently stellar performance of the pension fund, Ross Goobey acquired a reputation as “one of the most successful professional investors of all time” and, through his public advocacy of equity investment by pension funds, as the “father of the cult of equity – see Reference 1.

But company directors and pension fund trustees have become much more risk averse in the face of tougher regulations and such scandals as the collapse of the BHS pension fund where company directors tried to get rid of their pension liabilities.

We have now swung to the other extreme where pension fund managers are looking to have guarantees that they can match their future pension liabilities with no risk. That typically means buying gilts. But this has meant that investment firms have adopted leveraged Liability Driven Investment schemes (LDIs) which aim to produce higher returns than gilts. This came to a sticky end when interest rates rose sharply and pension funds had to dispose of holdings to match their collateral liabilities.

There is no way you can avoid risk if you wish to get a decent return. Investing in equities is more likely to give a good long-term return that is better than fixed interest, particularly in periods of high inflation which is where we are now.

The cult of the equity may have gone too far in the 1970s but the reversal is just as disconcerting and has led to the lack of investment in UK companies that we now have.

How do you fix the problem of lack of investment? Obviously you could do it by juggling the tax system to provide more returns on risk investments like equities. But the Government needs to look at why pension fund trustees and managers have become more risk averse which has resulted in lower returns. Excessive regulation is certainly one issue to look at.

More direct intervention in what pension funds can invest in is surely a mistake. Bureaucrats always fail to pick the commercial winners and forcing more investment in equities will undermine the market equilibrium.

Ref. 1 Cult of Equity

Roger Lawson (Twitter:  )

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One thought on “Should Pension Funds Invest More In Equities?”

  1. I completely agree that govt ministers are the wrong people to tell Pension `Funds where to invest. Since over all long periods equities (capital plus income) have outperform govt bonds, it is surprising how long the “match assets and liabilities exactly” has lasted. This has been due to poor, timid and often ill informed regulation.

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