Pay more or work longer

The UK’s risky approach to pensions investment has not paid off in recent years. John Greenwood assesses the consequences

Workplace pensions took another blow to the body last month with the publication of a report from the Organisation for Economic Co-operation and Development (OECD) report that placed the performance of UK funds third-worst in terms of investment performance since the turn of the millennium.

The OECD report shows that through the 2000s pension funds in the UK delivered a real return of -0.1 per cent, and managed just -1.1 per cent over the period 2007 to 2010. The OECD looked at figures across all types of pensions, both defined benefit and defined contribution, and found only Spain and the US performed worse in the list of 22 countries compared in the survey.

Newspapers seized on the numbers and once again the UK pension system was portrayed as failing British savers. But Juan Yermo of the OECD’s financial affairs division, one of the report’s authors, rejects such a simplistic take on the UK’s performance. He says: “The numbers look terrible for lots of countries.

“But the story is simple. The countries with funds with higher equity exposure have done worse than those without. And we have had countries such as Chile who have invested domestically, and their economies have done well.”

Chile tops the table with an annualised return through the Noughties in excess of 5 per cent, clearly benefiting from positive returns from its bonds, which performed well, as well as from the fact that as an emerging economy, its domestic equities have performed well. But Germany achieved annualised real returns of around +3 per cent over both periods covered by the OECD report. So is there something fundamentally wrong with the UK’s attachment to equities? Yermo thinks not.

“We don’t think the UK numbers are down to bad investment management. The numbers look terrible for lots of countries”

“We don’t think the UK numbers are down to bad investment management. We could see a return to equity returns, in which case the UK will do better, or we could not. If you do long term analysis you can come up with an argument that you always want some diversification. But diversified growth funds can have maybe 70 or 80 per cent equities in there. And if you go the other way you can miss the train if growth does come along,” he says.

Auto-enrolment places the investment strategy question even further up the agenda. And while the benefits of diversification have been talked up in the advisory community for several years now, what actually happens on the ground for the thousands of existing schemes that will be receiving newly automatically enrolled members from October is a different matter.

How providers, employers and intermediaries deal with legacy business is set to be a major challenge. Yermo may not blame the UK pensions industry for the recent poor performance, but he would doubtless frown upon the fact that currently there are untended legacy schemes out there that are 100 per cent in equities right up to retirement age.

“There is a lot of legacy business out there. Lots of people are in funds that they never ever think about. And when you think of some of the aggregator businesses, whose business model is to keep admin down to an absolute minimum and leave things as they are, you wonder how that tallies with active governance of DC,” says Mike Morrison, head of pension development at Axa Wealth. “Yet active governance of DC default funds has to be the way forward.”

For Yermo the real conclusion from the report is not that the UK, or any other country that has done badly should beat itself up and try to rethink the way it approaches investment – although there is always room for improvement – but instead the message should be that contributions will have to increase.

“We have to look at the numbers and say we have had a whole decade where returns have not been what we expected. That then means only one of two things – either people will have to make additional contributions or they will have to work longer,” says Yermo.

“All schemes that are going to be used for automatic enrolment have to meet certain qualifying criteria,” says a spokesman for The Pensions Regulator. “There is default fund guidance from the DWP and from the Investment Governance Group. This says that investment strategies need to be suited to the workforce of the members.”

The DWP has said it may issue statutory instruments to enforce best practice if its guidelines are ignored. With little commercial benefit for aggregator businesses to improve the DC offerings they present to thousands of savers, it may have to.