Many pension funds are outperforming their benchmarks, but only because the benchmarks are set too low, a new report claims.
Research by the University of Bath has found that the performance of pension funds owes less to the investment skills of pension managers and more to the selection of benchmarks which are easy to outperform.
The study found that a relatively simple and passive strategy of investing 80% of the fund in the FTSE benchmark and 20% in one of several emerging market equity indexes would on average allow funds 'specialising' in UK equity to outperform their benchmark by 3%-4%.
The research found that part of the problem is that pension funds aren’t being measured against benchmarks that accurately match what they invest in.
When a new pension fund is created, a Primary Prospectus Benchmark is chosen to compare the fund's performance against. But the fund is allowed to invest in a broader spectrum of assets than its official description and benchmark may suggest.
For example, a fund that is classified as UK equity can invest up to 20% of its assets under management in investments outside of UK equity. If the benchmark against which the fund is being judged is 100% UK equity focused (for example the FTSE All Share Index) then the fund has a natural advantage.
“This study provides convincing evidence that pension funds are reporting their performance in relation to benchmarks which are not reflective of their true investment profile,” says Ania Zalewska, Professor of Finance at the University of Bath’s School of Management.
“It creates a spurious impression of good investment skills for consumers who are paying a premium for actively managed funds.”
How to measure your pension’s performance
There is no single way you can get an accurate idea of whether your pension funds are good or bad.
“It can be very difficult to review the performance of your underlying investment funds. The challenge is to determine what you compare their performance against,” says Patrick Connolly, a certified financial planner at Chase de Vere.
You can compare them against a stock market index, but as the University of Bath’s study has shown you may not get an accurate comparison as your fund may be able to invest in a broader range of investments than the index.
Alternatively, you could compare your fund against the investment sector in which it sits.
“This can provide a reasonable guide, although many investment sectors contain funds which adopt wide ranging and different approaches in terms of where and how they invest,” says Connolly. “This should be used as no more than a broad guide.”
A more accurate way to monitor your fund's performance is to research other funds that are similar to yours. That means they have a similar aim and investment criteria.
You can then compare your fund's performance against these similar funds.
Switching pension funds
If you think your pension fund is underperforming, first take a look at why. Check if anything has changed within the fund that could help future performance, such as a new manager.
If you’ve done your research and you still aren’t happy you can switch to a better performing fund.
Nearly all pension providers offer a range of funds for you to choose from so see if there is another fund that offers better performance – just make sure you take a look at the fees and charges to make sure your better returns won’t be wiped out by costs. And remember that just because a fund has perfomed well in the past, there's no guarantee that it will continue to do so.
If your provider doesn’t offer the funds you want to invest in, check whether another pension provider does and consider switching your pension to a different provider.