Budget is chance to right a pension wrong

There is just a chance that Jeremy Hunt may on Wednesday start to right a great wrong. It concerns the disastrous way pension funds invest our savings.

Every year the London Business School with Credit Suisse (now taken over by UBS) produces the Global Investment Returns Yearbook. This looks at share prices, bonds and cash in 90 markets around the world, going right back to 1900 on 23 of them. 

The latest report came out last week. Its message is that if you invest in equities in any major market, reinvesting the dividends, your savings will over the long term beat inflation by a large margin.

The best market is the US, with a real annual return over 125 years of 6.5 per cent, just ahead of Australia. The UK had a 4.8 per cent real return, while in Germany and France it would have been a bit over 3 per cent.

But if you put your money in government bonds, your real return would have been between 1 and 2 per cent in most markets, including the US and UK. And you would have lost money had you invested in bonds in Japan, Germany, Italy or France.

Are equities more volatile? Most people assume they are, and that is the argument for pension funds preferring bonds. But the study shows collapses in bonds have been almost as serious as those in equities. In the US, the worst crash was from 1929 to 1933, when shares lost nearly 80 per cent of their real value. But the second worst was in bonds in the early 1980s, when they dropped nearly 70 per cent. The recent falls since 2021 have been more serious in bonds than in equities.

The thing I found most surprising in the report, however, was the extent to which the US market has dominated global investment. In 1900, the value of the UK market was slightly larger, but by 1913 the US had overtaken it. For most of the period from then right through to the late 1980s, when Japan briefly topped the US in value, American shares have accounted for more than half the market. Now they account for 60.5 per of global value, dwarfing Japan with 6 per cent, the UK at 4 per cent, and China and France, both 3 per cent.

But isn’t there a danger that US markets are overly dominated by the Magnificent Seven, Microsoft, Apple, Amazon, and so on?

Well, no. The US is actually one of the least concentrated markets, as the top ten shares there account for just 25 per cent of the total. Here our top ten account for 36 per cent. In both France and Germany they are more than half. There is safety in breadth, in that a high-tech crash would do less damage, provided the value of the other companies held up.

There are other surprises, including the case for buying corporate bonds. There is a boom in issues of these right now. The LBS team found the higher yields on these more than compensate for the higher risk.

And looking ahead? You have to hang a wealth warning over any projection of future investment returns. But, for what it is worth, the authors calculate that people starting to save for a pension now, Generation Z, should expect an annual real return of 4.5 per cent on global equities compared with 2 per cent on bonds.

All this makes our pension funds’ disinvestment in UK equities outrageous. They, with other institutional investors, have gone from owning half the market in the 1990s to less than 4 per cent.

It is a point I and my colleagues here make often, and it is a theme gaining traction in the City. There is a further twist, with the bias not only against equities in general, but UK ones in particular.

Simon French, chief economist at Panmure Gordon, points out that in every other country the pension industry over-weights its holdings in its domestic companies. In the UK it under-weights them by 41 per cent. That’s nuts.

So, Mr Hunt, here’s your chance. Reverse that tax grab by Gordon Brown in 1997 on dividends paid to pension funds, and set in motion radical changes in the regulations that pushed them into this absurd situation.

Everyone saving for their old age, especially Generation Z, will be deeply grateful.