Recently released figures confirm that the proportion of equities in UK pension funds' portfolios dropped dramatically in the first decade of the 21st century. Pension Funds Insider considers the fallout

The results of BNY Mellon bank's latest pension fund survey suggest total equity holdings amongst UK-based pension funds fell from the lofty heights of 73.5% in 2000 to a more modest 51.4% in 2010. Figures held by Pensions Funds Online mirror this story and show that in the same time period, equity holdings in UK pension schemes have fallen by 21.6%

Many commentators have spoken of recent stock market woes forcing an end to a British 'cult of equities' that started with Imperial Tobacco Pension Fund's radical shift to 100% equity exposure in the mid-1950s, while US private sector funds also downsized their equity holdings from 70% to 55% in the three years from 2006.

A symbolic point in the demise of equities came last year as dividend yields on equities overtook those on government bonds last summer for only the third time in 50 years. 

The marked decline in equity holdings can be attributed to the growth of liability-driven investment as defined benefit schemes mature as much as funds falling out of love with them, says Professor Charles Sutcliffe of the University of Reading. The academic told Pension Funds Insider: "While the changing structural liabilities have pushed schemes into bonds there has been an added realisation that equities are not just a license to print money."

UK is biggest loser

The BNY Mellon figures also showed a sharp drop in UK equity holdings from 51% in 2000 to 23.7% in 2010 while over the same period US equity holdings increased from 4.7% to 9.7% and emerging market stock holdings from 0.7% to 3.5%.

The bank's performance and risk analytics manager Alan Wilcock confirmed there has been no let up in the trend over the most recent calendar year, saying: "During 2010, UK pension funds continued the long-term trend of investing less in equities and more in bonds and inflation linked gilts as well as diversifying their equity holdings more internationally, particularly in emerging markets."

Sutcliffe said this confirms that "schemes are realising its sensible to look globally" adding that in 2004 in his own fund management career as a director of the University Superannuation Scheme (USS) he swapped some £4bn approximately of UK equities for foreign equities.

Sutcliffe, who wrote an article questioning the 'cult of equities' amongst UK pension funds back in 2005, dismisses any talk of funds' caution on UK equities damaging the economy, saying "the overall affect of UK-based pension schemes on our stock market is fairly modest. We are in a global market and if funds are selling UK equities there are always others, often overseas investors, there to buy them."

Others are distinctly pessimistic, however. Citigroup's Robert Buckland wrote in a September 2010 report that "the demise of the equity cult will continue to have profound implications for the global economy and markets. It is likely to keep capex levels subdued. Why bother to build when you can buy existing assets cheaply?"

What goes down must come up?

Richard Murphy, the Keynesian head of the Tax Research UK foundation, is an economist who would like the great equity sell-off to go further, as he questions the economic and social value of equity investing for pension funds.  Murphy advocates that all pension funds should be made to invest 25% of their holdings in infrastructure instead "in order to create capital now to fund future generations' retirement."

He told Pension Funds Insider that in his view "it is quite rational that pension funds are not putting money into UK equities as corporate growth prospects are poor", echoing Buckland who warned that "it will take more than the avoidance of a double-dip to turn the equity outflows around. Sure equity prices would probably rise in the short-term if that were to happen, but a sustainable re-rating could only be achieved if investors were to be attracted back to the asset class."

While the impending full maturity of most DB schemes does indeed suggest the slow sell-off will continue, most defined contribution (DC) schemes are happy to continue the tradition of strong equity holdings. Pensions consumer insight firm DCisions recently confirmed that the vast majority of default funds have a heavy preference for equities, although Murphy warned "it worries me that NEST and other DC funds are putting all their money in equities".

Mainstream investor opinion is that despite the rebalancing of portfolios away from equities, having them as the biggest asset class is still a sensible long-term bet rather than an irresponsible gamble. Matt Phillips, investment director of BDO Investment Management recently told Pension Funds Insider that despite current macroeconomic uncertainty in European debt and high oil prices "there are quality companies out there who have come out of the crisis in rude health and with good cash holdings that can produce a pretty good return over the longer term".

The latest BNY Mellon figures of a 51.4% average equity weighting in 2010 are just slightly down from 52.1% at the end of 2009 report, which may hint at the downward trend levelling out as some funds defy the naysayers to snap up bargain post-crisis stocks.

First published 04.05.11

dbillingham@wilmington.co.uk