Looking at the broader picture

Steve Mingle is the recently appointed group pensions and benefits director of Diageo, the food and drink retailing, brewing and distilling group. Together the GUD Pension Trust and Grand Met Group Pension Fund, the two main final salary schemes for which Mingle is responsible, hold assets valued at in excess of £2bn ($3.3bn).

At the end of a couple of weeks in which world stock markets tumbled - and then rebounded, there was melt-down in the bond markets and the dollar lost one fifth of its value against the yen, it was comforting to find that Mingle was not losing sight of the longer-term issues facing UK pension funds.

Top of the list is the minimum funding requirement (MFR). Evidence suggests that the trustees and employers of larger pension funds prefer an investment policy that will mean that their pension fund is to some degree mismatched against the MFR. This means they can profit from the outperformance of equities over fixed interest, even if this means that it would be prudent to run a surplus to cushion short term market volatility. Is there a strong argument for such an ap-proach?

Yes, if the company has a cashflow sufficiently strong enough to absorb any special contributions", says Mingle, adding "A funding target set significantly above the critical level (eg 120% of the MFR) should minimise the risk of such contributions being re-quired, whilst allowing the flexibility to 'mismatch'. Over the longer term, this ap-proach should produce the lowest cost to the company."

A second issue centres on the relative merits of active and passive management. Mingle holds that the fundamental case for active management is based on two premises: the first is that certain managers will outperform their index after fees, the second is that trustees and their advisers will be able to predict in advance which managers these will be. "I wonder whether either of these conditions is upheld consistently enough for their combination to prove beneficial," says Mingle, "I suspect that the expression 'You'd have done better indexing' is heard all too often at UK trustee meetings."

The third issue causing concern are the proposals set out by the Accounting Standards Board in its recent discussion paper concerning accounting for pension costs. What would be the effect if these proposals were put into effect? "I think that the move to a market-based approach is inevitable and that this will generate more volatile pension costs." He explains that this will mean the finance di-rectors will need to consider the merits of smoothing pension costs by adopting a more cautious investment strategy, set against the increased long-term cost created by the resultant lower returns. Roger Self"

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