This fundamental change in investment approach could mean equities would form a smaller proportion of portfolios particularly in pension fund where the proportion of pensioners in retirement is rapidly overtaking the proportion of contributing members. As this trend accelerates, pension fund managers need the certainty of bonds to produce income to pay
Will 2005 prove to be a better year for equities than 2004? Opinions are mixed but there are some trends which do not look too encouraging.
UK equities will suffer from the continuing disinvestment of the life and pensions funds as they seek to match liabilities with assets and meet regulatory requirements.
We have already seen Standard Life sell off some £7.5 billion of equities to meet the FSA regulatory requirements and others have been reducing their equity holdings for a similar reason.
As the emphasis in pension funds switches from capital growth to providing income for the increasing number of retired pensioners, there will be further reductions in equity holdings. Boots pension fund has completely liquidated its equity holdings and is now entirely in bonds. Although much smaller, Britannic revealed last week that its company pension scheme is now two-thirds in bonds.
Investors cannot ignore the effect the big institutional funds are likely to have on share prices, nor the fact that it has been estimated that the next five years’ profits of the FTSE 100 companies will be swallowed up in plugging the black hole in their pension fund deficits. This does not leave much scope for paying dividends and some share prices are likely to suffer.
Standard Life recently published a paper setting out the sea change in investment thinking amongst life companies, the long-term funds, and in particular pension fund managers seeking to deal with deficits in defined benefit schemes.
‘Recent accounting and regulatory changes mean there has been a much greater focus on the difference between the value of assets and liabilities,’ explained Euan Munro, head of strategic solutions at Standard Life Investments.
‘This has led the investment industry to question whether these investors might be better served by liability driven investment (LDI) rather than solely trying to out-perform a given benchmark.’
Munro thinks that the changes are fundamental and long term. ‘Some commentators believe that the demand for LDI solutions would wane if there was an improvement in global equity markets or a rise in bond yields such that deficit problems became less acute,’ he said.
‘However, we believe the recent changes to accounting and regulatory measures signify a fundamental change in approach to investing is required. Our analysis indicates that an evolution is taking place within the fund management industry.’
