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Special Report: The Top 100 – the flight from equities

“Jackal’s Director of Pensions, Simon Kew, looks at the impact of quantitative easing (QE) on pensions schemes and bonds.”



The FTSE 100 may be up, but pension funds continue to pile out of shares. Mark Leftly looks at an apparent paradox

The FTSE 100 is buoyant. For the first time since October 2007, the index topped 6,800 points in May, following the longest run of daily gains in nearly two years. Bearing in mind that the credit crunch so devastated equities, to the extent that the blue chip index plunged to little more than 3,500 points in the wake of Lehman Brothers’ collapse, this is a remarkable comeback.

Analysts at Citigroup have even forecast that the FTSE could smash the 7,000 barrier by the end of 2013, citing a “real equity bull market in the next couple of years”. Yet pension schemes, arguably the investors that big corporates most rely on to provide their share capital, are no longer buying British stocks. In 2002, pension schemes allocated 61% to equities, which fell to 56% five years later.



By 2012 the allocation was just 45%, according to consultancy Towers Watson. Among the top 100 pension funds the £5bn increase in the value of equity holdings masks the fact that the proportion of investments held in what was, until recently the mainstay of pension fund investment has slipped by 1%.

Given that UK equities outperformed gilts by about 10% in 2012: static holdings would have resulted in the equity weighting moving higher but in fact it fell

Alternatives, such as infrastructure investment and private equity, and even incredibly low-yielding government bonds are on the up, while the biggest scheme managers hiked their accumulation of cold, hard cash. Glyn Owen, investment director of asset manager Momentum, says that despite the increased allocation to equities, it looks from the figures as if pension funds were net sellers of equities during the period covered by the survey. He says: “Given that UK equities outperformed gilts by about 10% in 2012: static holdings would have resulted in the equity weighting moving higher but in fact it fell. This suggests pension funds continue to focus on matching liabilities and reducing volatility but are not capturing as much of the big bull market in equities that they might.

Why otherwise buy this expensive asset class?” A key issue is that defined benefit pension schemes are, typically, reaching the end of their lives. Only around one in eight DB schemes are still open to new members in the private sector, according to the National Association of Pension Funds, as opposed to two in five in 2005. As an increasing proportion of scheme members are retired rather than actively working and paying into the fund, so pension managers must de-risk their allocations.

There has been an undeniably downward trend for maybe as long as 10 years in equities investment, since the tech bubble burst

They cannot afford to gamble on investing in a volatile stock market and potentially widening any deficit. “There has been an undeniably downward trend for maybe as long as 10 years in equities investment, since the tech bubble burst,” says Paul Chapple, director of institutional investments at Close Asset Management. “The scheme’s profile changes quite quickly as you don’t get the contributions in. The trend is increasingly away from equities, so there is a move to fill that space with alternatives like commodities and hedge funds.”


Some fund managers are eyeing up emerging market debt as a strong, liability-matching investment, particularly as the very term is misleading: economies such as China, South Korea and Brazil emerged long ago and still have plenty of scope to spend on developing their roads, schools and hospitals. A sound alternative, then, where growth should be sustainable. As Ashmore Investment Management portfolio manager Julie Dickson recently argued, emerging economies will “drive global growth for years to come”.

Chapple, though, isn’t convinced. “The argument put forward is that the developed world has large levels of debt compared to gross domestic product and low interest rates, while the emerging market has a lower percentage debt to GDP. However, this is not risk free – countries still default and something always crops up.” Indeed, Francis Yeoh, the Malaysian billionaire and owner of Wessex Water through his YTL Corporation, warns that China doesn’t have effective utilities regulation. For example, he cannot see a Japanese company being allowed to own a Chinese water company, so maybe a decade’s time Beijing could face problems in improving basic infrastructure for its huge population.

That’s a very specific but potentially huge example of assuming that even the more secure asset classes will remain that way in perpetuity. As Chapple argues, there are always dangers with emerging markets. The overall trend is sometimes described as the death of the cult of equity and that demise has been hastened by tighter regulation, particularly rules that have been developed as a result of the recent economic crisis.

The country’s 6,000-plus DB pension schemes now hold more in bonds than they do in equities: those stringent regulations mean that big corporates don’t want to end up paying extra money into a scheme on the back of a hunch that the boom times are back.

Pension funds have their hands tied behind their backs on allocation

Darius McDermott, managing director at Chelsea Financial Services, sighs: “Pension funds have their hands tied behind their backs on allocation. That lack of flexibility is to the detriment of the pension holder. While I know some bond managers who don’t actually hate their own asset class, there are few who think they will be getting the double-digit returns that they have enjoyed previously. Equities relative to bonds are good value, but pension fund managers have not been able to re-allocate to equities in the size that they would have liked to.”

The very safest government bonds, such as Germany and the UK, are so low yielding as to potentially deliver negligible returns at best, once administrative and management fees are factored into the investment. And while quantitative easing should have pushed managers away from bonds given how the programme pushes down their yields, it might just be that this has created even more uncertainty in the market. Simon Kew, director of pensions at Jackal Advisory, thinks so.

He argues that QE might have made bonds “unpalatable”, but the desperate measures in place to fix broken economies only generates fear over potentially volatile asset classes such as equities. “I think that when the market is shot to pieces then that’s a good time for pension funds to get in,” he says, while acknowledging that this hasn’t happened. Despite the particularly strong equities run of the past six months, Tapan Datta, Aon Hewitt’s head of asset allocation, says that equities’ inherent volatility means that even those tempted to go back to the stock exchange will ultimately resist that gamble. “There is a growing willingness and appetite to look more broadly,” argues Datta.

“Some are resigned to buying bonds at expensive levels, but others are looking at allocations that are higher yielding. Within corporate bonds they might look a little more kindly on, say, emerging market debt. The dilemma is that by getting out of equities, you still end up taking a bit more risk within fixed income.”


The Universities Superannuation Scheme is nearly 40 years old, but less mature in its life cycle than most of its peers. The UK’s second biggest pension scheme had £36bn of assets under management as at the end of 2012, and around half of its allocation is still in equities – though this has been at more than 70% in the recent past. Chief investment officer Roger Gray points out that the time to de-risk out of equities is when they are up rather than down.

Piling into equities right now might not be a wise move, given they are so close to their historic height. USS has been careful in picking out its alternative investments and has looked further afield than the run-of-the-mill infrastructure or hedge funds: it has around 0.5% allocated to timber. With houses being built at a pace around the world to accommodate a fast-growing world population, this is an asset class with an obviously healthy future.

“There is also the attraction that should the higher demand for timber not be there you can let your trees grow; there is a harvesting programme that you can run,” explains Gray. “Timber’s done extremely well over the past 15 years. It’s a terrific investment: a real asset, with organic growth – no pun intended.”

One thing that everyone should worry about is who are the natural owner of equities in the future. It won’t be insurers, because of [the regulatory restrictions of European Directive] Solvency II

There are, then, lots of investment options out there, so managers must look carefully for them if the equities story really is reaching a conclusion. Perhaps those who should worry most about this trend are not the pension schemes, but the FTSE companies themselves. Ian Barnes, UBS Global Asset Management’s head of UK and Ireland, says: “One thing that everyone should worry about is who are the natural owner of equities in the future. It won’t be insurers, because of [the regulatory restrictions of European Directive] Solvency II.

It’s not clear who are going to fill the gap that pension funds are leaving.”

Equities remain risky and volatile.

Wounded by the burst of the tech bubble and a seemingly never-ending financial crisis, pension schemes have been forced to conclude that all bets now are off, so chief executives of major corporates must seek out new owners as they rebuild their balance sheets.

Category : Savants in the News — admin @ 11:00 pm May 30, 2013

Regulator cuddles up to employers

“Simon Kew calls on his experience of the Pensions Regulator, to highlight that there has always been a focus on the investment strategy of schemes.”

Funding statement focusses on collaboration

The Regulator is softening up. That is the message from its latest annual funding statement. The language is much more conciliatory than last year’s – expectation has been replaced with collaboration. As Xafinity director Hugh Creasy says, “the tone of the statement is oh so different”.

The Regulator has used this year’s statement to move away from specific triggers towards what it calls “integrated risk management”. Schemes are advised to look at governance, and the scheme’s current financial situation “in the round,” says Graham Wrightson, a partner at Stephenson Harwood, and make more subjective decisions on that basis.


The aim is to strike the right balance – the statement urges trustees to “allow for an appropriate level of risk…that is neither overly prudent nor overly optimistic”.

The tone of the statement is oh so different

The new approach has been welcomed for introducing more flexibility into the process. But with increased flexibility comes greater uncertainty. Because the guidance is less stringent it is more nebulous, so trustees have to work harder to decide what is right for their scheme.

They could also end up paying more for the privilege. The Pension Protection Fund warned in its 2013-16 Strategic Plan that this more lenient approach from the Regulator could force the PPF to hike its levies up.  This is because the new statement is more accepting of employers paying less into their schemes, which would drive up deficits and expose the PPF to greater risk of corporate insolvencies.

Following strict guidelines has not allowed for the change in the economic conditions

However, Parminder Latimer, a director at Pitmans law firm, says the Regulator’s approach could still be helpful because “following strict guidelines has not allowed for the change in the economic conditions, and the changes to employers and their cashflows”.

Where there are serious concerns about affordability, schemes “may wish to think about contingent assets,” said the Regulator’s chair, Michael O’Higgins, addressing delegates at this year’s Workplace Pensions Live conference. This too indicates an ideological shift towards accommodating the employer as the Regulator has historically been fairly reticent on this subject.

The statement is laying the groundwork for the upcoming code of practice

He spoke on the day when the Queen’s speech confirmed the Regulator’s new objective to take into account the impact of recovery plans on the sustainability of the employer. He was keen to impress, however, that it has not come into force yet, so schemes should look to existing guidance, including this year’s funding statement.

It would be naïve to suppose, though, that the drafters of this statement ignored the new objective entirely. The wording of the statement shows that it is laying the groundwork for the upcoming code of practice, which “will need to make some pretty explicit references I think to that new objective, and to the role it has”, says Creasy, who thinks this statement is effectively “bridging the gap”.

The statement is very employer friendly

All in all, this year’s statement was very employer friendly, and more pragmatic than the previous offering. Creasy believes the Regulator has learned a great deal over the last year, and has “come to recognise that they need to be able to fight the political front as well” as setting out technical requirements.

Covenant has been at the heart of the Regulator’s set up since it came into being

The most significant changes confirmed in this statement have been the result of long periods of transition – the Regulator has been slowly moving away from triggers for some years. “Covenant has been at the heart of the Regulator’s set up since it came into being, and they’ve always had an eye on investments,” adds Simon Kew, director at Jackal Advisory.

Policy is only now catching up with practice, or, as Wrightson puts it, the Regulator is “catching up with the rest of the industry”.

Category : Savants in the News — admin @ 11:00 pm May 21, 2013

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