Pension funds warned over faith in bonds

By Ian Fraser

Sunday Herald

March 9th, 2008

THE TRUSTEES of UK pension funds, who oversee the investment of £900 billion of assets, have been chastised for their blind faith in the bonds market during a speech at a major investment conference in Edinburgh.

UK pension schemes have, over the past seven or eight years, dramatically reduced their exposure to UK equities. Instead, they have invested in lower-return government and corporate bonds, partly driven by uncertainty over the future of equity market returns following the bursting of the dotcom bubble.

Speaking at the NAPF investment conference in Edinburgh, Danny Truell, chief investment officer of the £15bn Wellcome Trust, said: “UK pension funds have invested too heavily in UK corporate debt. One of the problems associated with this is the lack of good governance.”

Truell said that over the past 10 to 15 years, investors have made great advances in pushing for higher standards of governance on the equities side; a move that Truell said had been pioneered by former Hermes Pensions Management chief executive Alastair Ross Goobey, who died last month.

Truell accused pension funds of having a blind spot when it comes to the governance of companies to which they lend money (by buying their bonds). He warned this could have painful consequences since 70% of UK corporate bonds are issued by so-called “financials” – banks and life insurers, some of whom have shaky balance sheets at the moment.

“There is no register or disclosure of who owns a company’s bonds,” Truell said. “Also, there is not much transparency from the pension funds’ perspective of what corporate debt they actually own.”

Truell said that the Wellcome Trust has a net internal rate of return of about 22% per annum on the back of a diversified investment strategy, with over 50% of its portfolio invested in alternative assets. These include hedge funds, private equity, property and infrastructure funds.

Arno Kitts, head of institutional business at Henderson Global Investors, called on pension funds to think more “clearly and creatively” about governance issues and to be “brave” when considering alternative investment opportunities. Kitts said: “Bonds will not fund pension schemes and might even cause problems in the long-term.”

Kitts said that pension funds should be able to “harvest the illiquidity premium” if they could only “wean themselves off their obsession with liquidity”. Generally, alternative assets produce better, more consistent long-term returns than equities and bonds. The negatives are that fund managers specialising in these areas tend to demand higher management fees – and alternative assets are usually less liquid than equities and bonds, meaning they are harder to sell at short notice.

This article published under the headline “Pension trusts warned over faith in bonds” in the Sunday Herald March 9th, 2008.

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