The Bacon & Woodrow/ BGI/FTSE multinationals index initiative to solve the problem of UK pension fund overweighting in ostensibly UK companies that do a large part of their business overseas has attracted strong criticism since coming to light earlier this year.
Although analysts concur with Bacon & Woodrow partner Nick Fitzpatrick’s criticism of “slavish weightings” by UK pension funds in stocks that bear “little correlation to the UK economy”, many add that the index proposal is a square peg in a round hole.
John Ilkiw, director of consulting at Frank Russell, comments: “Specific risk for pension funds is not index-based, it is just that the asset mix policies authorised by UK trustees are not well thought-out. If you take a step back and examine the problem it is a simple allocation issue of risk control. You don’t have to create a whole new matrix system confusing the existing indices and causing yet more definition problems without clarifying the issue. The problem is being chased with the wrong solution.”
Ilkiw notes the irony in Microsoft not being considered as a multinational whilst Diageo in certain circumstances would be included. And he adds that the UK minimum funding requirement is another misnomer in the debate .
“The common problem here seems to be over-engineered solutions generated in principle by smoothing processes in actuarial textbooks which are wrong and increasingly recognised as such by the actuarial community.
“Pension plans are not actuarial problems, they are finance problems and require finance principles to be applied to their investment.”
Ilkiw says the real issue is how the fund liabilities behave and how to market price liabilities, instead of artificially excluding them. “Then you look at the assets which match the liabilities and you have the minimum risk position. Once you decide to mismatch your risk – then that’s the asset allocation decision, and you have to ask whether you get paid for this in exchange for the risk. A company’s inflation-driven pension promises are backed with equities and you hope there is enough surplus growth over time either to make the plan cheaper or accrue benefit and sterilise the risk.”
He feels that if actuaries have been able to convince the regulators and pension trustees over confusing and poorly designed pension fund actuarial architecture, then there really shouldn’t be a problem in getting the right message across once problems begin to arise.
Ian Martin, principal at Morgan Stanley, adds: “The multinationals index solution to this hang-up of UK pension funds and domestic overweighting in stocks that have very little relevance to the domestic market is patently wrong.
“What pension funds need is a meaningfully thought out and constructed global equity approach, not this peer group-driven approach to investment.”
However, Morfydd Evans, partner at consulting actuary Bacon & Woodrow, comments: “I am a bit disappointed the debate has taken this turn, because most of the points raised are fairly trivial in my view. Certainly from a client perspective the reaction has been very positive, with the view being that as soon as the fine tuning is done we should get the index off the ground.”
Evans says Bacon & Woodrow certainly does not see this as an interim solution to the debate. “The pension fund over-concentration in UK stocks is very much an issue and the issue of companies like BP Amoco just being headquartered in the UK is important, with companies like Glaxo Wellcome having less than 10% of business in the UK. Anyway they all approach their business in a global manner and the index is the best solution to the problem at the moment.
“ Pension funds want to hold the best stocks in these particular fields, hence the index. We are not aiming to badge this as a Bacon & Woodrow/BGI product, and the issue is in the hands of FTSE as to when it will be up and running, which I believe will be before the end of the year – so I’m not sure why there has been such a rebuttal from some other consultants.”
Dow Jones Indexes in New York are also on the cusp of releasing a new ‘Titans’ index of the largest global stocks.
Michael Petronella, managing director of Dow Jones Indexes, says: “ We don’t view this as a potential multinationals index, but an index of the largest of the large stocks.
“ In terms of the methodology used in constructing the index, we have used various measures of size, not just market capitalisation but sales and assets also.
“Investors are looking for the play on the largest multinational stocks, but we have been very careful here to make the index one that reflects companies for who they are along with the fact they may have multinational characteristics.”
Petronella adds that an official announcement on the Titans index could be made this month, but that it will definitely be launched before the end of the summer.
FTSE has also launched its own super liquid e-stars, containing 29 stocks from amongst the largest and most liquid companies from the euro-zone countries. This is being touted as a transitional bridge for traders yet to enter the European derivative trading zone.
The index will be visible and was available from June 14 with futures and options launched on it on both the AEX and Liffe exchanges from June 29.
Traded on five markets, the extremely liquid stocks incorporate eight French, eight German, seven Dutch, three Spanish and three Italian companies, and represent nearly 40% of the total market capitalisation of the FT/S&P Eurobloc benchmark.
George Moeller, chief executive of Amsterdam Exchanges, said: “E-stars is a very attractive proposition for the market: compact, very liquid, and designed in a style that mirrors the smaller indices of the continent.”