UK Sponsors Chart Move from Pensions to DC

December 4, 2007 ( - UK pension plan sponsors have begun to construct the investment framework through which they will manage existing final salary plans down to zero over the next generation while transitioning employees to defined contribution structures, Greenwich Associates said in a press release.

The results of Greenwich Associates’ 2007 United Kingdom Investment Management report reveal UK local authority pension funds are making a strong move into so-called “portfolio-wide strategies” such as asset-liability matching, general liability-driven investing, and various absolute return approaches.

Though plan sponsors are moving to put into place the defined contribution structures as retirement programs for employees closed out of traditional final salary plans, because the vast bulk of UK pension assets still reside in final salary structures, they are devoting most of their attention and resources to perfecting their final salary management practices, according to the release.

Greenwich Associates said its research suggests that UK plan sponsors have not considered the full ramification of the risk/return profiles associated with these new strategies. UK pension funds say they expect their investment portfolios to outperform the market by an average 118 basis points (bps) per year, while UK corporations say they expect their investments to outperform the market by 124 bps each year. These expectations far exceed those reported by institutions in other countries, Greenwich reports.

“Frankly, we do not believe that the expectations of UK pensions are realistic,” said William Wechsler, in the release. “In the United States, a very small share of institutions achieve 100 bps or more in annual alpha over a long-term horizon in their equity portfolios. The 118 bps expectation reported by plan sponsors in the United Kingdom includes many asset classes with less opportunity for alpha generation.”

In 2003, slightly more than 40% of U.K. companies had closed their final salary plans to new employees; in 2006 that share reached 61%; and over the past 12 months it increased to 68%. Another 3% of corporate plan sponsors said they expect to close their plans in the next two-to-three years.

Nearly 85% of UK plan sponsors have established defined contribution plans and another 13% said they expect to add a DC plan in the next two-to-three years.

Allocations to domestic equities by UK pension funds declined to 28.4% of total assets in 2006 from 32.0% in 2005. Since 2002, pension fund allocations to UK equities have fallen some 9.6%. Greenwich said these changes have been driven largely by cuts made by corporate plan sponsors, which have been prompted by mark-to-market accounting to try to reduce portfolio volatility.

Overall allocations to fixed interest and alternative assets classes were essentially unchanged from 2005 to 2006. Among the more than 70% of UK pension plan sponsors that said they expect to make significant changes to their asset mixes in the next two years, one-third plan to make substantial increases to their property allocations.