Portfolio Selection and the Investment Performance of the UK Pension Funds*

Abstract

Pension funds are the main institutional investors, accounting for 38 per cent of personal sector net financial wealth. As a result of their growing importance in mobilizing personal sector saving, they have emerged as the principal institutional investor, controlling over £200bn of funds at the end of 1987, their total net assets equalling 38 per cent of personal sector net financial wealth. Pension funds also dominate domestic asset markets, owning 27per cent of the stock of outstanding UK equity, 23 per cent of UK government securities and 17 per cent of total UK holdings of overseas equity. In this paper we present the conclusions from recent research, undertaken as part of an updating of the LBS Financial Model. Our results suggest that UK pension fund investment since 1980 is better than previous studies have suggested and, in particular, that funds outperformed the equity market in the 1980s, offering a higher return for any given level of risk. In addition fund behaviour is slow to change, with past behaviour exerting the strongest influence on current investment patterns. Fund managers also appear guilty of “short termism” in that they place little weight on events beyond the next three months. However, this has not made them inefficient. Finally, we find that actions to restrict the funds' surpluses should not affect their investment behaviour. Our results also suggest that the costs from exchange controls in the 1970s were substantial, amounting to some £4bn per year.