Pension schemes in the UK are losing out on £1.7bn in potential annual returns by accepting passive-style performance from actively managed funds.

According to Aon Hewitt, at the end of 2013 £840bn out of £2trn of assets managed by the UK's pension industry was invested in equities.

Aon Hewitt said that £460bn of the £840bn was actively managed, with the remaining £380bn held in passive funds.

Around 75% of the £460bn actively managed assets were, and still remain, allocated to core active funds, which only track their benchmark, resulting in UK pension schemes receiving sub-optimal returns on approximately £350bn of assets, Aon Hewitt said.

According to the consultant, if these assets could deliver an extra 0.5% a year either through better returns or lower fees then that would be an extra £1.7bn in the real value of pension plan assets per year.

John Belgrove, Aon Hewitt senior partner, said that trustees should review their equity portfolios to ensure they are getting the appropriate performance from their investment strategy.

He said: "Schemes committed to an active approach should steer clear of managers that charge a high fee for essentially matching an index. To deliver performance in excess of the benchmark, schemes must be willing to take risk and follow a broad, unconstrained strategy using the very best ideas and with the highest conviction managers.

Belgrove added: "Undoubtedly, high conviction portfolios demand a large commitment of time, resource and budget from trustees to deliver long-term outperformance.

"We find strong evidence that better results require stronger governance. Governance-constrained schemes may therefore benefit from seeking help with manager selection and implementation responsibilities."

Aon Hewitt partner Tim Giles said that trustees should also check that they are achieving the best possible performance if trustees have a preference for passive equity management.

He said: "Rather than following the herd and focusing on mainstream indices, schemes should consider the potential benefits of a smarter approach to passive management. For example, tracking alternative indices has frequently been shown to provide schemes with better risk-adjusted returns over the long term."

First published 21.05.2014

monique_simpson@wilmington.co.uk