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What drives UK defined benefit pension funds' investment behaviour?

Author

Listed:
  • Douglas, Graeme

    (MKP Capital)

  • Roberts-Sklar, Matt

    (Bank of England)

Abstract
We have developed a structural model to explain defined benefit (DB) pension funds’ investment behaviour. The model is calibrated to the aggregate UK DB pension fund and four different cohorts of funds. We use the model to estimate how pension funds can be expected to adjust their asset portfolios in the face of different exogenous shocks. Our results suggest that pension funds are sensitive to shocks that change their funding ratios — that is, the ratio of pension assets to liabilities. Deteriorations in funding ratios encourage pension funds supported by financially weaker corporate sponsors to switch some equity holdings into bonds. This is because reduced funding ratios weigh on the perceived vulnerability of already weak corporate sponsors. But similar deteriorations in funding ratios encourage funds supported by financially stronger corporates to increase their equity holdings to benefit from their higher expected returns. In contrast, shocks that result in material improvements in funding ratios — for example, resulting from a large rise in interest rates — encourage all pension funds to increase their bond holdings to ‘lock in’ those improved positions.

Suggested Citation

  • Douglas, Graeme & Roberts-Sklar, Matt, 2018. "What drives UK defined benefit pension funds' investment behaviour?," Bank of England working papers 757, Bank of England.
    • Handle: RePEc:boe:boeewp:0757
    as

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    File URL: https://www.bankofengland.co.uk/-/media/boe/files/working-paper/2018/what-drives-uk-defined-benefit-pension-funds-investment-behaviour.pdf
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    References listed on IDEAS

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    Cited by:

    1. Giovanni di Iasio & Spyridon Alogoskoufis & Simon Kordel & Dominika Kryczka & Giulio Nicoletti & Nicholas Vause, 2022. "A model of system-wide stress simulation: market-based finance and the Covid-19 event," Questioni di Economia e Finanza (Occasional Papers) 687, Bank of Italy, Economic Research and International Relations Area.
    2. Aikman, David & Chichkanov, Pavel & Douglas, Graeme & Georgiev, Yordan & Howat, James & King, Benjamin, 2019. "System-wide stress simulation," Bank of England working papers 809, Bank of England.
    3. di Iasio, Giovanni & Kryczka, Dominika, 2021. "Market failures in market-based finance," Working Paper Series 2545, European Central Bank.

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    More about this item

    Keywords

    Pension funds; procyclicality;

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors

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