Woodford slams UK’s £1trn pension deficit

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UK pension schemes should be increasing their allocation to equity income stocks rather than poorly performing bonds, according to Woodford Investment Management.

Longer life expectancy and investment returns that are lower than anticipated contribute to the estimated £1trn liability shortfall in the country’s defined benefit schemes, head of investment communications Mitchell Fraser-Jones says in the firm’s latest blog post.

Fraser-Jones says: “The biggest problem, however, has been the progressive decline in bond yields, most recently exacerbated by the Bank of England’s decision to cut interest rates in the aftermath of the UK’s decision to leave the European Union.”

He questions why defined benefit schemes have increased their allocation to fixed income over the last decade when the case for equity income is “obvious”.

Pension schemes have cut their exposure to equity from 60 per cent in 2005 to 43 per cent in 2015. In contrast bond exposure has increased from 25 per cent to 37 per cent.

Over a similar period bond yields have fallen. A decade ago 10-year gilts would return 4.5 per cent compared 0.56 per cent today. In contrast the FTSE All Share returned 3 per cent in 2006, compared to 3.89 per cent today.

Fraser-Jones says: “We would argue that the yield on UK equities is so attractive right now that it can serve a dual purpose for investors.

“Savers that are still some way from retirement can reinvest income and benefit from Einstein’s eighth wonder of the world, long-term compounding.

“Those that are in retirement can, in a brave new world of pension freedoms, enjoy an attractive income stream from UK equities and hope to see that income grow over time – after all, that is why equities are called growth assets.”

Asset allocation within pension schemes has become focused on “liability matching”, “de-risking” and reducing scheme volatility, says Fraser-Jones.

“To us this doesn’t make sense. If the age-old relationship between risk and return continues to hold true, ‘de-risking’ must also mean ‘de-returning’.”

However, Fraser-Jones issues a word of caution regarding equity income.

“There remains a risk of dividend cuts in some parts of the market and there is a need to be vigilant and selective in order to avoid dividend disappointments.”

In recent months, the Woodford Equity Income fund revealed it had sold its position in BAE Systems and BT amid concerns regarding pension deficits. It has also noted that it has a reduced conviction in Royal Mail due to concerns regarding its pensions obligations.