Real Estate Research

Mr Micawber's illuminated guide to DC pensions and property

The value of defined contribution (DC) pension schemes in the UK is set to rise  sharply as employers close traditional defined benefit (DB) schemes to new  members and as auto-enrolment extends private pensions to a further nine million  employees. 


Mark Callender

Mark Callender

Head of Real Estate Research

Scott Lothian

Senior Strategist, Global Strategic Solutions

Neil Turner

Neil Turner

Head of Property Indirect Investment and Research


The value of defined contribution (DC) pension schemes in the UK is set to rise sharply as employers close traditional defined benefit (DB) schemes to new members and as auto-enrolment extends private pensions to a further nine million employees. Spence Johnson estimate that the total value of DC pensions will triple
from around £276 billion in 2012 to approximately £825 billion in 2022.1

This article looks at two key risks for an individual with a DC pension. First, the risk of poor investment returns in the decade prior to retirement. Second, the risk that their pension is insufficient to meet their needs in retirement. In both cases, we consider how investing a proportion of a DC pension scheme in property might help mitigate these risks. Along the way we catch up with our old fictional friend Mr Micawber who started life in Charles Dickens’ David Copperfield2, but now has a second career as an unauthorised financial consultant.

DC pensions and the importance of investment returns close to retirement

A major but often-overlooked feature of DC pension savings is that the final value of the pension pot - used to buy an annuity or a drawdown product - is highly dependent upon investment returns in the final 10 or 15 years before retirement. The simple reason for this is that, unlike in a traditional collective DB pension scheme, an individual’s DC pension pot starts at zero and then builds up over time, hopefully reaching a maximum at the point of retirement. While investment returns in the early years of the scheme will have some impact on the final value of the pot, it will be relatively modest because the value of the accumulated contributions is initially quite small. By contrast, the impact of investment returns in the decade prior to retirement is critical, because at that point the returns are acting on a much larger sum of money.


Figure 1 highlights the sensitivity to this ‘sequencing risk’. The Actual experience line shows the value of a hypothetical pension pot for someone who took out a DC personal pension on 1 January 1973 and retired forty years later on 31 December 2012. We have assumed for the sake of simplicity that the individual had average earnings, that they routinely saved 10% of their income, and that they maintained a constant 60:40 allocation between equities and gilts. By the time they retired they had a pension pot of almost £470,000, equal to 13 times their annual salary in 2012 and their pension contributions had an effective money-weighted internal rate of return (‘IRR’) of 10.3% per annum. 

The orange line shows an alternative scenario of what might have happened had there been a bull market in equities and gilts in the critical period leading up to retirement. We created the alternative scenario by simply switching the relatively poor returns of the 2000s with the relatively strong returns of the 1980s. The switch has no impact on compound annual total returns over 40 years measured on a time-weighted basis, because they ignore the amount of capital invested (as in DB pension funds). However, the switch has a major impact on the final value of the hypothetical DC pension pot, because the strong returns in the final decade before retirement were acting on a much larger sum of money. In the alternative scenario the final value of the pot is nearly £1,000,000 - equal to 27 times the individual’s salary in 2012 and the money-weighted IRR on their contributions is 13.6% per annum. In short, therefore, the final value of a DC pension pot is very dependent on the path taken.

Can property help people saving in DC pensions?

How should individuals saving for a DC pension try to deal with this sequencing risk? It is easy to look back and assess its effects, but much harder to predict due to the time horizons involved. When we look at the main cause of sequencing risk we find it is the volatility of equity markets, in particular, which savers should be wary of. When we discussed the issue with Mr Micawber his advice was to cross fingers and hope for an equity bull market in the ten years before retirement. As Mr Micawber likes to say, “something will turn up”.

A second approach, which we think savers should seriously consider, is to further diversify their portfolio by investing in other assets, such as property. The main attractions of property are that returns tend to follow a slightly different cycle than equities and are less volatile. Traditionally, property has been a good diversifier of equity risk. This is because capital values and total returns have been driven by rental values and the current state of the economy, rather than by expectations of future economic growth.

In figure 2 we compare a portfolio containing only equities and gilts to one with a 10% allocation to property, consistent with our example above. Using forward looking return expectations and historical volatility we find that an allocation of 10% to property provides two major benefits: lower expected volatility for a marginal reduction in expected return, and a reduction of risk concentration in equities.

There is a trade-off for achieving this lower volatility, and hence less sequencing risk exposure. Property investments are inherently less liquid than financial assets and long-term total returns have lagged behind those of equities. Thus, if our hypothetical saver had invested for 40 years in a portfolio with 50% in equities, 40% in gilts and 10% in UK property their pension pot would have increased more smoothly than in the base case, but its final value in 2012 would have been around 5% lower. 

1. Broad Brush, Spence Johnson. December 2012.

2. David Copperfield, Charles Dickens, 1849-1850.

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