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Pension funds “need more bonds”

UK – Barclays Capital has pitched into the debate over the role of bond in pension funds, saying there are six good reasons why UK pension schemes need more bonds

The firm cites the maturity of UK schemes, scheme deficits, equities’ risk and the bond-like liabilities of pensions as being among the reasons pensions need more bonds.

Earlier this week the president of the Faculty of Actuaries, Tom Ross, said the case for investing a pension fund portfolio entirely in bonds is far from clear.

There has been some high profile moves into bonds by pension funds, notably the pension fund of UK retailer Boots, which has shifted its entire portfolio into bonds.

The first reason Barclays Capital cites for the importance of bonds is the maturity of UK schemes. “UK pension schemes are very mature – only about a third of pension scheme members are currently active.”

Second, it says, “surpluses afford the luxury of equity risk, deficits don’t”. It sums the situation up: “If you’ve lost your shirt, is it really wise to bet your trousers on the expectation that you’ll win back your shirt?”

Third is the “contingent risks of equities”. Fourth: “Equities have got riskier relative to bonds.” For whatever reasons, equities are riskier, so that “for a given level of risk tolerance, you should hold fewer equities now than you did in the past”.

Citing the Faculty and Institute of Actuaries, it notes that pension liabilities are “bond-like”. It notes that the FRS17 accounting standard does not “create” or “exaggerate” pension fund risk - it exposes it.

Lastly, it asks: “Whose risk is it anyway?” It explains: “The ‘economic risk’ of a pension fund is borne by the sponsor company while it remains a going concern, and the assets of a pension fund are effectively ‘collateral’ against the liability more than they are the one and only way of meeting liabilities.”

Barclays, in a 100-page survey on equities and gilts, says that figures suggest that pension funds lost enthusiasm for sterling bonds in mid-2000, becoming net sellers, and have only recently started buying again in a small way.

“Of course, bonds have grown as a proportion of assets held in a passive way because of relative market value changes, and there have been a few high-profile
shifts to bonds by individual schemes that have garnered a lot of press coverage.”

But, says Barclays, “it appears that as far as the flow data is concerned, over the past three years funds have actually been selling bonds to buy equities (more accurately, they have been selling gilts to buy overseas equities)”.

“A significant part of this was probably mechanistic rebalancing away from bonds by balanced portfolios with fixed percentage asset allocation targets, as world stock markets fell.”

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