MONEY COMMENT
Another Bad Year For Pensions

By Cliff D'Arcy
January 14, 2003

Unsurprisingly, UK pension funds suffered another year of investment losses in 2002. The latest annual survey from investment consultancy The WM Company - covering over 1,000 funds worth over £420bn - shows that the value of a typical pension fund declined by an estimated 14% last year.

This is the worst result since 1974 and completes a hat trick of negative returns: on average, an average fund has shrunk by 8.2% a year for the last three years. This is the first time this has happened since The WM Company began compiling its pension performance tables in the mid-1970s.

These falls have placed a considerable strain on pension funds, with assets falling and liabilities rising (largely thanks to us all living longer).

Recent government regulations and accounting standards have put further pressure on pension funds, causing many firms to close their schemes to new members. Even worse, some employers are closing guaranteed final-salary schemes and switching existing employees to more risky money-purchase plans, which are usually linked to stock-market returns.

In order to spread their risk, most pension funds own a wide range of assets, chiefly shares, bonds, property and cash. Pension funds usually hold a high proportion of their capital in shares, typically around 65%. This is down from a high of over 80% in the mid-1990s.

By falling 22.5% last year, UK shares held in pension funds were the biggest contributors to the overall 14% decline, with international shares dwindling 24%.

In contrast, UK bonds returned about 9.7%, with international bonds up by 9.3% and property up by 8.9%. This growth helped to offset some of the losses caused by shares, demonstrating the value of diversification.

Last year, insurance funds were forced to sell shares and buy bonds in order to prevent their assets falling too much over the short term. However, pension funds actually increased their ownership of shares during 2002. Pension funds, being true long-term investors, can afford to accept the volatility of this strategy in order to benefit long term.

Even though many employers appear to have lost faith in final-salary schemes, it's still clear that a substantial investment in shares is appropriate - even essential - to make pension schemes succeed. So, if you're saving for the distant future, it's appropriate to act like a pension fund and keep your exposure to shares high.

More: Last year's pension fund results | Visit our Pensions Centre.