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New warning over schemes’ equity concentration

UK - UK pension funds’ tendency to expose themselves to a handful of FTSE companies could end with the collapse of some of the big names, says Hymans Robertson principal George Henshilwood.

He said concentration was a 10-year-old problem that is still unresolved - although a reduction in equity exposure is now taking place in the UK.

“It’s something that concerns us a great deal and it’s difficult to see the problem concentration being resolved until some of the big names collapse, which would create a mess that obviously nobody want to see,” he said at a seminar organised by T. Rowe Price.

There was an example of this recently in Ireland, where pension funds suffered following a steep decline in drugmaker Elan's shares.

Henshilwood suggested that pension funds change their equity weighting to US equities. North American equities, whose market cap is 60%, should be allocated between 35% and 45% of the equity portfolio.

European, ex-UK equities, which have a market cap of 20%, should get a 25% to 35% slice. Pacific ex-Japan between 10% and 12%. This allocation compares with a 4% market cap.

Pension funds which cannot afford to switch their asset allocation in favour of bonds, could try to find opportunities in equities markets.

But Henshilwood warned that as “liabilities work both ways” these opportunities should be eventually used to take risks “off the table”.

“The flip side is to understand that things can go wrong, that equities may not outperform and you got to have a plan”, he said, suggesting that trustees must be satisfied that the sponsor would put more money in the scheme if things go wrong.

Trustees are becoming more alert to liabilities but pension funds need to push their focus towards higher alpha generating mandates to balance risks, he told IPE. He said the style issue is “ quite significant”.

“While there has been a tailwind behind value investors you can’t help thinking that the music is about to stop,” he said.

Henshilwood also commented about alternative investment classes. He observed that hedge funds’ capacity was constrained with many players “chasing the same amount of alpha”.

He said Hymans has “bought” that commodities provide a degree of diversification, but added that the issue of returns in the long run was not clear. He also said property was “the flavour of the month” and wondered whether we had seen the best of high yields.

“We are appropriately sceptical about LDI liability driven_investing,” he added – arguing that the strategy could see the rerun of balanced mandates.

“The manager has to gave good capabilities in equities and bonds, maybe in property and alternative investments, just like before, but managers are not good at everything.”


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