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The Actuary The magazine of the Institute & Faculty of Actuaries

Investing pension funds in equities

I’ve been a life office actuary for virtually the whole of my career (35 years but who’s counting?) but, having been elected a trustee of my employer’s pension scheme, have had to take an interest in pensions matters lately.

The pensions world currently seems to face even more issues than the embattled life insurance industry but there is one issue on which your readers might be able to put me straight. The issue is whether the pension schemes’ so-called love affair with equities has ended.

I completed the examinations by passing the investments and pensions papers in 1974, when equity markets were groggy and gilt yields were in double figures and rising.

As far as I remember, I was taught that pension scheme liabilities were linked to earnings in deferment and to RPI in possession. No investments were guaranteed to match these links but equities and property were the best bet because company earnings and commercial rents could be expected to move in line with economic growth as could earnings and prices. Bonds (there were no RPI-linked ones in those days) provided a poor match but had a role to play in backing pensions in payment, as they were less volatile and virtually risk-free.

The charge levelled against schemes now is that equities were never a good or least bad match for the liabilities. Schemes invested in them because their sponsors, egged on by investment and actuarial consultants, were taking a big bet that they would outperform bonds. The bet has failed so schemes must radically rethink their investment strategy.

There have been changes since 1974, not least that typical schemes are more exposed to pensions in payment than to active members. However, there is still an inadequate supply of both fixed bonds with terms long enough to match the liabilities and RPI-linked bonds.

The current criticism of equity investment, therefore, seems to imply that corporate earnings and commercial rents will display weak correlation with economic growth and that inflation will remain close enough to zero that an RPI-linked liability can be closely matched by a fixed bond with, typically, a shorter mean term than the liability.Have I got that right?

PS If the charge against equities were coming from teenage scribblers I could understand. But I found this on a Reuters report today:

‘Stephen Cooper, head of valuation and accounting at UBS investment bank, said companies should give up attempting to leverage the supposed superior returns in equity markets to try and reduce the costs of their pension funds and should switch to more predictable and tax efficient returns from bonds.

“I think companies should fund deficits immediately, borrow money and repay them. They need to switch out of equities and into assets that match the long-term nature of their liabilities and stop these hidden leveraged investments embedded within the firm,” he said.’