UBS survey: UK pensions outperformed inflation over past 50 years

UK pension fund returns have outperformed increases in UK retail prices and wages significantly over the past 50 years, a study by UBS Global Asset Management has found.

Between 1963 and 2012, the average fund returned slightly above 10 per cent – 4.2 percentage points ahead of retail price inflation and 2.6 percentage points above wage inflation, UBS’s latest annual pension study reveals.

Ian Barnes, head of UK and Ireland at UBS GAM, says the figures show that defined benefit schemes had done what they were meant to do over the long term, despite facing volatile conditions.

“Essentially, the whole point of the DB pension market is to collectivise risk and to allow a population of investors to take risks that perhaps on their own they wouldn’t be comfortable taking,” he says.

The findings also support the widely held – and hotly pursued – view that equities perform better than bonds over the long term. The report showed that UK equities produced an average return of 11.8 per cent annually in the 50 years to 2012.

Figures for 2011, however, were not particularly stellar, with pension fund returns falling to 3.6 per cent and slumping behind retail price inflation. Despite this stall, returns bounced back in 2012, hitting 8.4 per cent.

For the 10 years to 2012 the average UK fund returned 8.3 per cent – slightly lower than the return over 50 years.

Mike Taylor, chief executive of the £4.6bn London Pensions Fund Authority, says his scheme, which has more than 70 per cent allocated to equity-type investments, has seen returns along these lines over the past 10 years – just under 8 per cent, against inflation of about 3.25 per cent.

“Equities are a good long-term hedge for inflation, but the problem with equities is that they are so volatile you may not get that hedge against inflation in the medium term,” he says.

Alongside UK returns, the UBS study additionally looked at global asset allocation trends, which confirmed that the trend away from equities and back into bonds has continued.

Compared with 2011, 2012 saw a move out of domestic into international traditional securities, with no increase in exposure to domestic equities among any of the world’s main pension markets.

Funds in Sweden and Australia decreased their allocations by 6 and 5 percentage points respectively in 2012, to 12 per cent and 23 per cent.

The US was the only country to lower its allocation to overseas bonds. US exposure to domestic bonds and equities also fell by 6 percentage points to 29 per cent and 33 per cent respectively, with money being moved into alternatives.

Mr Barnes says that although the trend for implementing a liability-driven investment, which aims to better align assets and liabilities rather than just maximise returns, was gaining momentum among some of the big pension markets, there was less need for the US to reduce its equities dramatically.

“It is different in different markets around the world, but notably in the US because the US equity market makes up over half the world. There is less pressure to reduce US equities, whereas the UK market is only 10 per cent of the world.”

The UBS study also highlighted the growing interest in “smart beta” strategies, which are intended to provide better risk and return trade-off than normal market cap weighted indices.

Appetite for such strategies, finds the report, is expected to continue to grow. But it warns that the merits of such products “seem quite variable” in some cases.

According to Jérôme Teiletche, head of systematic investment strategies at Swiss fund house Lombard Odier, smart beta will grow to represent one-third of global institutional equity allocations by 2018.

There are different ways such strategies could manifest themselves, adds Simeon Willis, principal consultant at KPMG, the professional services firm.

“It is either schemes looking to access new markets at lower costs, or [pension funds] could be trying to do things in a mildly active way, but consistent with a buy and hold strategy, rather than an actively trading churning strategy,” he says.