UK – Concerns are mounting that British pension funds are exiting the equity markets despite the UK market having its best year since 1999. Could this cap the recovery as funds “cash in their chips”?

Investment manager Schroders notes that recent figures show UK funds have sold equities, pointing out that recent WM company figures reveal that funds disposed of 2.7 billion pounds (3.8 billion euros) in the third quarter of 2003. “Industry sources suggest that this has continued during the current quarter,” says Schroders.

“There is the fear that as the UK market recovers, pension funds will be looking to actively sell their holdings and switch into bonds.” In addition to necessary rebalancing, the pressures to sell comes from factors such increased diversification desires and fund maturity.
“In addition, there has been appraisal of the role of equities in pension funds.”

Schroders paints a scenario that as funds see their funding position improve due to equity and the rise in bond yields, they will be tempted to lock in performance by switching to bonds. “Some suggest that this will cap the recovery in the UK market as pension funds ‘cash in their chips’.”

Pension funds have been reducing their exposure to UK equities for a long time, say the managers. In 1993, pension funds held around 30% of the UK equity market, while overseas investors accounted for 16%. Since then, the position has reversed. currently, pension funds hold 16% and overseas investors hold 32%.

The presence of these and other investors, such as insurance companies, mean that equity values should not become “unduly depressed relative to other assets or equity markets overseas,” says Schroders.

If UK equities are expected to return 5.5% per annum, outperforming expected UK government bonds annual returns by over 3% and index-linked issues by 3.5%, Schroders doubts if this would be sufficient to prompt funds to switch to bonds. With the low yields on bonds, “this is not a particularly advantageous time to be switching away from equities”.

It adds: “Since most funds are in deficit, equities remain the only viable asset unless they are prepared to significantly increase their contribution rate.”