What the euro means for a pension fund in an ‘out’ country is an issue the British Steel Pension Fund addressed in the run-up to the introduction of the currency. Since then, a close eye has been kept on its implications for the fund.
The fund has over 95% of its £8.6bn (e13.2bn) of assets managed internally by a small team based in London covering the UK and main overseas equity markets, property and bonds. The Pacific Basin (ex Japan) and emerging markets are managed externally.
The fund is conservatively managed, with safety as well as performance receiving a high priority in investment policy and practice. This conservative positioning can be ascertained from the fact that real assets of index -linked, equities and property account for almost 80%, but total equities are less than 50%, and total bonds, both fixed interest and index- linked, come to about 45%. We do not invest in overseas bonds.
Included within the overall fund is a separately identified maturity portfolio consisting solely of fixed interest and index-linked securities and cash, to ensure that the performance of the fund can be clearly monitored.
As to the investment aspects of the euro, the asset allocation impact stems from the change in definition of ‘domestic’ assets from the local to the Euro-land market and although the UK is an ‘out’ country at present, it is not only our position that is important, but also the position of other investors in European markets.
As things stand, there is no pressing need to change the domestic equity orientation as a UK pension fund, but if we believe joining Euro-land is likely, or indeed inevitable, the fund will need to take this into account sooner rather than later. On a forward-looking view, a much higher proportion of equity assets are in the UK than would be justified by the UK’s proportion of a Euro-land including UK portfolio. But we are not rushing to do anything about it, apart from maintaining a small relative overweight position in continental European equities in relation to our UK peers.
There are a number of reasons for this. Unless we are very sure of the future, we tend not to place big bets on any particular outcome, be it in the future health of the economy or the success or failure of EMU. Thus it seems more appropriate to make any adjustments on a gradual basis. We know and are happy with our UK equity investments, and have confidence that UK companies are managed broadly for the benefit of shareholders. Although things are changing in Europe, they have a long way to go to catch up with the governance standards in the UK, and this provides a heavy bias towards UK investments.
Bonds have not been popular with UK pension funds because of the UK’s past proneness to inflation, but this does seem to be a less threatening risk in the present world economic climate. UK gilts have been signalling much lower investors’ concern about future inflation and joining the euro would reinforce confidence in this respect. The euro bond market will be enormous, and provided the European Central Bank retains good discipline, should be attractive long term relative to the US or Japan. These considerations would tend to make us rather more bond-friendly, but again a lot is in the prices, and so no major adjustment is warranted simply by the arrival of the euro.
The fund has only rarely held overseas bonds in the past, and does not hold any non-sterling bonds at present. We have not felt unduly disadvantaged by this. For the future, however, if the UK enters Euroland the exchange risk is removed from non-UK Euroland bonds, and these would undoubtedly be considered for investment.
Turning to portfolio structure within Europe, the fund’s European portfolios have always been structured as much on a sector basis as on a country basis, because different countries have clear strengths and weaknesses, largely reflected in their companies quoted on their stock exchanges. The European portfolio is viewed as a matrix, with countries along the top and sectors down the side, so our country/sector emphasis is immediately apparent, and is not very different to what would be expected: telecoms in Finland, drugs in Switzerland, autos in Germany and so on.
As Emu becomes more established, the fund will gradually move to an even greater sector emphasis. However, important cultural differences will remain, for example, between the north and south, and it is hard to foresee the time when country factors will be irrelevant. And regional differences will remain.
How will these factors affect the fund’s benchmarks? At the overall fund level we split out our maturity portfolio and benchmark the rest on a peer group basis – the WM50 primarily, so the benchmark will be affected to the extent that the body of the top 50 or so UK funds reacts to the euro. Within Europe, there is a veritable benchmark war going on, but this is not a critical issue. The FTA S&P Europe ex UK is used and the plan is to continue to do so for the time being. After all, the fund has the freedom to invest within or outside the existing Euro-land at any time.
Finally, the organisation. In relative terms, we have a large UK team and a small European team, which works independently. They are all in the same office, however, and the expertise of the UK sector specialists is available to the European team on an ‘as appropriate’ basis. So a UK person may sit in on a European company meeting with the object of adding value to both the UK and the European portfolios. No changes have been made to this organisation and none are planned for the immediate future. Clearly, if and when the UK enters Euroland, it would be appropriate to reconsider.
In summary, we have not felt it necessary to take major action as a result of the euro, but that does not mean we are in any way complacent. So we are keeping a watchful eye on developments.
Stewart Colley is investment manager at the British Steel Pension Scheme. The article is based on a paper given at the NAPF investment conference