UK - UK pension schemes may be exposing themselves to greater risks by switching all of their equity holdings into corporate bonds, according to consulting actuaries Lane Clark & Peacock (LCP).
LCP’s conclusion follows the recent move by the £2.5bn Boots Pension Scheme which saw the transfer of its entire assets into bonds. The switch has sparked debate as to whether other UK schemes are likely follow suit.
LCP highlighted three main reasons why a 100% switch may not be advisable: 1. By investing 100% in bonds a pension scheme fails to diversify, and by building up a portfolio of mainly AAA corporate bonds it also fails to ensure liquidity.
2. There is some default risk inherent in all corporate bonds, even triple As. LCP said it is impossible to find bonds with maturity dates long enough to match the 25-30 year time scale of pension payments. The firm added that because the vast majority of corporate bonds pay a fixed interest coupon, funding levels could be squeezed hard should there be a future burst of high inflation.
3. Bond-only investment may require additional long term employer contributions. In the case of Boots Pension Scheme, for example, that may result in £30-£40m a year being trimmed from its profits, based on LCP’s own actuarial assumptions. But it is possible that these additional potential costs will be offset by the enhanced shareholder value that will accrue from reducing overall risk from its pension fund.
LCP partner Jeremy Dell said: “There is increasing pressure on finance directors to control the very real risks posed by defined benefit pensions arrangements.
“A 100% AAA bond strategy may appear sensible in terms of mitigating investment risks, but the company and its workforce may be assuming other risks as a result.
“Ultimately they may miss out on the superior long term returns that almost always accrue to long term equity investors.”
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