What Drives UK Defined Benefit Pension Funds' Investment Behaviour?

24 Pages Posted: 13 Oct 2018

Date Written: October 5, 2018

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.

Keywords: Pension funds, procyclicality

JEL Classification: G23, G11

Suggested Citation

Douglas, Graeme and Roberts-Sklar, Matt, What Drives UK Defined Benefit Pension Funds' Investment Behaviour? (October 5, 2018). Bank of England Working Paper No. 757, Available at SSRN: https://ssrn.com/abstract=3261257 or http://dx.doi.org/10.2139/ssrn.3261257

Graeme Douglas

Bank of England ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom

Matt Roberts-Sklar (Contact Author)

Bank of England ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom

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