Feature – Focus on pensions: Emerging pension fund options

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Defined contribution (DC) pension plans are increasingly offering equity funds that invest 50% in UK equities and 50% globally.

The emerging markets have been performing well of late but could be hit by rising interest rates around the world.

Employers with schemes offering investment funds in emerging markets should ensure staff take independent financial advice.

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When it comes to the fund choices offered to employees in defined contribution (DC) pension schemes, UK equities are a popular option. According to Julian Webb, executive director at pensions management company Fidelity International, 100% of the firm’s clients offer UK equities as an investment choice. However, fund managers also realise that it is good for staff to be able to spread the risks, so many offer a fund option which is made up half from UK equities and half from global equities. "We are seeing more and more plan sponsors offering global equity funds, which typically will be on a 50-50 basis, so 50% UK and 50% the rest of the world in key equity markets [like] North America, Europe (excluding the UK) and the Far East," Webb explains.

Another type of equity fund that employers are showing an interest in, is the emerging markets such as Eastern Europe, Latin America, China and India. Webb explains that around 20% of Fidelity’s clients offer a fund made up purely of stocks from the emerging markets, but as a fund which is selected by staff, rather than one that is included as a default option. "We are seeing an increasing interest in higher alpha funds [which] would include specialist equity funds like emerging markets. If [the member is] relatively young and can afford to take a risk, then clearly there is the opportunity for the out performance on those particular funds," he adds. The emerging markets have produced high returns over the last three years.

However, interest-rate rises globally, particularly in the US, are likely to have a knock-on effect, making the emerging markets and equity investment in general less attractive over the next 12-to-18 months. Gerard Lane, a strategist at Morley Fund Management, explains: "Within the financial markets, we have had a very strong period of returns over the last three years from equities globally, with the leaders being the emerging markets. Over the next two years, we would say that the environment for equities is likely to become less favourable because interest rates around the world are going up. The knock-on effect of that is that economies slow down." In particular, conditions in the US could have repercussions for markets elsewhere. "If the US economic conditions slow more quickly than the market is anticipating then it is likely that the dollar will weaken and that [is] likely to lead to poor returns from US assets."

Should this occur, however, the impact on markets outside of the US is likely to be far greater. "If the US market goes down 5%, Europe often goes down 7%-8% and the emerging markets often go down 10%-12%, despite the emerging market economies and the European economies being quite robust at the moment," explains Lane. So employers with schemes offering investment opportunities in the emerging markets as a fund option may want to ensure employees take some independent financial advice. However, they shouldn’t be deterred from offering the choice to more sophisticated pension fund members who understand many of the risks involved.