On the political economy of UK pension scheme regulation

We take the opportunity of the recent Consultation Exercise on UK defined–benefit pension schemes conducted by the Pensions Regulator to examine the approach to pension scheme portfolio management that it and the related Pension Protection Fund have adopted. After summarising the regulatory basis, we identify three essential building blocks for further examination: the notion of matching liabilities to long–term (government) bonds, the use of standard deviation of return as a measure of risk and the idea that strategic asset allocation is the most important decision in portfolio management (this last one, the Brinson axiom). We examine these foundations individually and then collectively with the aid of two unobtrusive postulates—the first being the efficient markets hypothesis and the second that pension scheme assets should be used to purchase only those securities with minimal default risk. From the perspective of what we have elsewhere called the Keynes–Graham schema, we conclude that the foundations are unsound and that the conventional approach, adopted not only by both the Regulator and the Protection Fund but also by the major actuarial consultancies, induces, if not actually requires, pension schemes to engage in speculation rather than investment.