Members of UK defined contribution (DC) pension funds may be unaware of their equity investments’ global income, as research showed disparity in geographical and economic exposures.
The study, published by the UK’s Society of Pension Professionals (SPP), found DC default investment funds invested some £20bn (€25.5bn) in equities, with a 41% allocation to UK-listed stocks.
However, this domestic bias is not realised in reality, with the funds’ economic exposure to the UK at just 13.6%.
One-quarter of equity value is achieved in North America via an average 19.5% allocation, and 23% from emerging markets despite a 6% allocation.
The SPP gathered allocation data from DC default investment funds within its membership and said its report, ‘The Allocation Illusion’, was designed to raise awareness rather than invoke change.
Roger Mattingly, former SPP president and initiator of the study, said it was easy for investors to assume geographical allocation would be matched by economic exposure.
“This researched is aimed at discovering where the assets are exactly economically exposed,” he said.
“If there are problems in Ukraine, [we should know if] that has an impact on member investments, and we just didn’t know the answer.”
Old Mutual Asset Management (OMAM) and MSCI partnered the SPP in conducting the study, with the index firm calculating economic exposure from equity indices using company revenue.
Olivier Lebleu, head of international business at OMAM, said it was common for DC funds to have significant domestic asset allocation based on the cultural assumption that plan members would prefer this.
“The UK case is not abnormal, but what is abnormal is the nature of its stock market – one of the most globally diversified in the world,” he said.
“This is where its embedded assumption of DC members slightly breaks down.”
Lebleu added that the UK’s defined benefit (DB) sector had used this knowledge for some time, leading to a shift away from UK equity allocation – not just a result of de-risking but a more global mindset.
“That thinking has not yet been adopted by DC plans,” he said.
Lebleu said it would be difficult to deduce whether the DC plans surveyed could be more efficient by allocating to emerging markets directly, rather than via UK equity-led exposure.
“What is clear is that nobody has been able determine whether 20% emerging market exposure from a pure UK portfolio is efficient because the knowledge is not out there,” he said.
Steven Kowal, MSCI executive director for indices in EMEA and South Asia, said that, while the UK stock market’s emerging market exposure is not a negative, due to diversification, problems arise from being limited to sector biases for the UK economy.
He said DC plans using the UK stock market for global exposure would face consequences from not taking a wider view on allocations, and be limited to larger stocks, missing out on the long-term value added by smaller firms.
“This is what happens when you [investors] do not take a global view,” he added.
The study also highlighted an impact on allocations based on risk appetite for members, with some DC savers opting for lower-risk default investment funds.
Lebleu said the UK stock market had often been seen as cautious due to its relatively lower volatility, over the long term.
However, he added: “The UK index has a lot of companies exposed to emerging market revenues, so it may be those past volatility statistics change dramatically.
“If that is the case, having a high UK allocation in your cautious portfolio may not be as cautious as it seems.”