It is that time of year again. Numbers have been crunched, figures analysed, reports prepared. Trustees have received information on the year just gone and for most it has not been too bad. In the UK and US, equities outperformed bonds. Okay, in much of continental Europe this was not the case but, for a well diversified and hedged pension fund, returns were satisfactory, or at least would have seemed so were it not for the legacy of the three years 2000 to 2002 when so much value was destroyed for so many pension funds.
Still we can’t turn the clock back and wish we had done things differently. However, as the old saying goes: unless we learn the lessons of history we are doomed to repeat the mistakes of the past. Luckily there are plenty of analysts who can tell us just what has happened in the past and do their best to explain why.

One of the best analyses of the past century can be found in the ABN AMRO/London Business School Global Investment Returns Yearbook. I can commend it to readers. It is staggering to see what the authors, Dimson, Marsh and Staunton have done with 105 years of well-researched and analysed information.
Although pension funds are told to look over the long term, 105 years might seem to be taking things to extremes. However, there are some very interesting five-year figures. The problem for most pension funds is of course the short term, what is happening here and now and, unfortunately, few pension fund trustees have the time to properly analyse the past. I can’t see this changing as, with accountants now running the show, we are increasingly focusing on the short term. The days when trustees could rely on actuaries and actuaries could rely on smoothing returns and effectively ignore the market are long gone.
In the UK, actuaries are certainly in the firing line following an inquiry into the profession being carried out by Sir Derek Morris. He has already presented his key findings and policy opinions from his interim assessment paper to both of the UK’s actuarial bodies – the Faculty of Actuaries and the Institute of Actuaries. The profession seems to have accepted the criticism of their failings, especially with regard to Equitable Life, and appears to be moving forward. I am, however, sure that once the final report is submitted, the actuarial profession will not be held in quite as high regard as it was before.

However, regardless of who you blame for the present situation, you can’t ignore the fact that largely because of an unbalanced asset allocation and the poor investment returns of the last five years many pension schemes are facing serious problems of underfunding today. Whilst we can debate accounting issues and watch politicians trying to reform social security pensions, trustees have to find ways to improve the investment returns of their pension plans.
I am sure there isn’t a single solution, but proper risk management and asset diversification will play a strong part for many funds.
A number of pension schemes are re-examining derivative instruments and whether they can be helped by a more appropriate use of them. We are now starting to see UK pension funds consider an investment in commodities. Hedge fund investment has now been on the agenda for some time. Currencies and other alpha strategies are gaining favour and private equity investment might even seem a little passé.
However, the one strategy that really has delivered the goods for many pension funds is real estate. For many funds it has not only been the best investment sector over the last year, the past five years by far, but also the best asset class over 10 and even the past 15 years.
Such a pity, therefore, that so few funds had been advised to hold property investments in the 1990s. But even now property’s prospects still appear
reasonable. The yield is still generally above that on bonds and whilst we may not see much capital or rental growth in the short term, it does appear to be safe. The commercial property market does not seem overstretched in the way that UK and Spanish house prices are but whether funds should be increasing their real exposure now is a different matter. However, many funds worried about the same thing last year and the previous year, and missed out on solid gains as a result.

So how can you sum up property’s attractions? According to Peter MacPherson of ING Real Estate Investment Management, property provides steady capital growth, a substantial income and reduced volatility. Over the past few years it can be seen to have been a great diversifier, it has a fairly low correlation with other major asset classes and dramatic valuation shifts within the asset class are also quite rare.
No one is guaranteeing property will perform as well in the future as it has in the past but I think it has earned the right to be considered an integral part of a pension fund asset allocation strategy alongside bonds and equities, rather than just a member of the alternative investments sector.