The Bank of England published a discussion paper looking at the issue of procyclicality in pension fund investment, and at the potential for institutional investors to exacerbate market peaks and troughs.
The paper, published Thursday, also looks at life insurance firms.
The bank, which announced its upcoming paper to delegates at a conference hosted by the National Association of Pension Funds in June, acknowledged the “stabilizing influence” of both investors on the financial system.
However, it said it was also possible that the factors driving asset allocation — which it identified as market conventions, accounting rules and regulatory requirements — “may lead to outcomes that are suboptimal from the perspective of financial stability (through procyclicality) and long-term investment and economic growth (through an unwillingness to bear risk.)”
The paper found evidence of procyclical investment behavior by insurance companies, with withdrawals from equities following the 2001 dotcom crash, while U.K. defined benefit pension funds have “behaved countercyclically in the short term, while over the medium term a structural 'derisking' trend has dominated.”
The decrease in equity allocations as institutional investors move toward derisking strategies “are relevant to the willingness of (these investors) to bear risk in the longer term and are potentially significant for the appropriate allocation of capital in the real economy,” the paper said.
The paper was produced by the bank's Procyclicality Working Group and included members of the bank and executives from the insurance and pension industries. Representatives include Peter Davies, senior partner and co-head of developed markets strategy at Lansdowne Partners; Roger Gray, chief investment officer at Universities Superannuation Scheme, Liverpool, England, and CEO of investment management subsidiary USS Investment Management; and Roger Urwin, global head of investment content at Towers Watson.
While the discussion paper does not present policy conclusions or recommendations, it is hoped that it will initiate discussion and add evidence to the debate, the bank said in a news release.