UK pension funds losing out because of closet indexing

Pension planUK pension funds could be losing out on £1.7 billion (€2.1 billion) in potential annual returns by accepting passive-style performance in actively managed funds, known as closet indexing.

Data released by Aon Hewitt shows that of the £2 trillion of assets held in UK pension funds at the end of last year, £460 billion were held in actively managed funds.

It suggests that 75% of the actively managed assets were, and still remain allocated to core active funds, which “do little more than track their benchmark”, Aon Hewitt says.

As a result, funds are “receiving sub-optimal returns on approximately £350 billion of assets”. It is not always clear when investors are caught out by closet indexing, however.

Aon Hewitt calculates that these £350 billion of assets could deliver an extra 0.5% a year either through better returns or lower fees that would be an extra £1.7 billion in the real value of pension plan assets per year. 

John Belgrove, senior partner at the firm, says schemes committed to an active approach should steer clear of managers that charge a high fee for essentially matching an index. 

“To deliver performance in excess of the benchmark, schemes must be willing to take risk and follow a broad, unconstrained strategy using the very best ideas and with the highest conviction managers,” he says. 

“Undoubtedly, high conviction portfolios demand a large commitment of time, resource and budget from trustees to deliver long-term outperformance.“

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