Baby-boomers will one day want to spend the pension funds they've built up. The effect of this outflow of billions of pounds is causing fund managers some disquiet.
If you're aged between 35 and 50 and a member of a pension scheme, you are one of the reasons why pension fund managers sometimes lie awake at night. There are about 11 million people in this age group who will draw billions of pounds out of pension funds when they retire. Though not quite in a state of panic about this issue, investment specialists in the pensions industry do believe that it could have profound effects.
Given that British pension funds currently own about £300 billion in domestic equities - equal to about a third of the value of the stock market, this 'demographic timebomb' will undoubtedly have an effect on stock-market valuations. 'That's not to say that there will be a crash,' says Jim McCaughan of PDFM, one of the largest pension fund managers. 'But it's a very interesting issue.' The baby boom generations, people born between 1945 and 1960, are now getting to the stage where they are savers rather than borrowers. They are paying off their mortgages and building up substantial amounts of investments in pension funds, Personal Equity Plans and other investment vehicles. In many cases, their pension funds will be a larger asset than their houses.
In theory, if they started cashing in their pension funds on a massive scale, equity valuations could start to be depressed. 'There is a distinct possibility that we will be looking at declining cash inflows to pension funds,' says Geoff Lindey, chair of the National Association of Pension Funds' investment committee. 'It is not fanciful to imagine that we would have net cash outflows, rather than inflows. This might concern the Government, which would want to be raising equity for the private finance initiative.' Pension schemes which have a large proportion of members who are nearing retirement usually start to reduce their equity investments and to transfer their assets into fixed-income securities, such as gilts. The pension funds have to be far more cautious with the funds of people whose retirement is imminent: equities are best suited to people who can ride out the peaks and troughs of the stock market over a period of decades. Many large pension schemes were set up after the second world war and are now finding unprecedented numbers of people retiring.
The issue is something which both the investment industry and the politicians must keep a close eye on. But there are many other factors which could make it a less difficult issue in practice than in theory. For example, the population at large is now being encouraged to start saving for 'long-term care' in residential or nursing homes. The market leader, PPP Lifetime, estimates that over £2 billion could be set aside for this purpose by the end of the decade. This market barely existed three years ago, but is likely to grow rapidly as politicians come to realise the need to provide for a long-lived population.
Another cause for optimism is the need for Continental countries to start building up their own private pension funds. According to PDFM, the UK pension fund industry is four times as large as the Dutch pensions sector, the second largest private pensions industry in Europe. Continental fund managers will need to spread their risks by investing abroad. Some of their money would therefore be invested in Britain. Martin Slack of actuaries Lane Clarke & Peacock believes that many are worrying too much about the effects of the demographic timebomb: 'People who are receiving pension income still have to spend it. And in some cases they start to save it again.'