LONDON - U.K. pension plans are poised to increase their allocations to fixed income, and corporate bonds in particular, by around 20 percentage points in the next two to three years.
But few are likely to follow the example of The Boots Co. PLC Pension Scheme, Nottingham, by investing the entire plan in corporate bonds, according to Gareth Derbyshire, executive director in the European Pensions Group at Morgan Stanley Investment Management Ltd., London.
Boots officials shocked the U.K. pension industry late last month by announcing the radical overhaul of the L2.3 billion defined benefit plan.
The Boots restructuring has opened up a schism in the U.K. pensions industry between those who believe pension plans should invest in bonds in order to reduce risk to the plan sponsor and those who believe equities provide the best long-term returns.
U.K. pension plans traditionally have been heavily invested in equities.
The new structure is intended to ensure the plan will always be able to pay its pensions, said John Watson chairman of the Boots plan trustees.
Over the last 18 months, the fund has invested 75% of its assets in AAA rated 30-year bonds issued by supranationals such as the World Bank or European Investment Bank. The rest of the assets are invested in index-linked gilts to give some protection against inflation, said John Ralfe, Boots' head of corporate finance. The assets had been managed in a balanced portfolio by Schroders PLC, London.
The restructuring no doubt will reduce volatility of the company accounts under a new accounting standard called FRS 17, which requires companies to record their pension plans on the balance sheet. But this was not the intention of the restructuring.
"We would have done this if FRS 17 had not been introduced," said Mr. Ralfe.
Standard a catalyst
But the new accounting standard will be a catalyst to encourage most U.K. pension plans to increase their allocations to fixed income, said Morgan Stanley's Mr. Derbyshire.
"I would not be surprised if in three years' time the average plan has 10 to 20 percentage points more in bonds than at the moment," he added.
U.K. pension plans had an average allocation to fixed income, including corporate bonds, of 20% at the end of June, according to the latest figures from WM Co., Edinburgh.
Shyam Mehta, head of insurance and pension strategy for BNP Paribas, London, welcomed the Boots move.
"Pension funds investing in equities are destroying shareholder value, which leads to a loss in competitiveness, and why would anyone want to do that in the long term?" he said.
For defined benefit plans, paying benefits had nothing to do with the investment return of the funds, he added.
He agreed that investing wholly in fixed income would not completely remove risks for a pension plan. But the risk that remains is "a much lower risk than the trustees and the company are taking on when they invest in equities," he said.
But representatives of leading U.K. pension plans were skeptical about the Boots move.
"They are exchanging the potential outperformance of equities for less fluctuation of costs," said Colin Hartridge-Price, chief pension officer for the L24 billion BT Pension Scheme, London. At the end of last year, the plan had 11% of assets invested in fixed income. Mr. Hartridge-Price would not say whether the BT plan would invest more in fixed income because of the new accounting standard.
"This is entirely risk management driven and is driven by the company," said Gerry DeGaute, investment manager for the L16.3 billion Consignia Pension Scheme, London. Fixed income accounts for 12% of plan assets and the plan is not considering increasing its allocation to the asset class, he said.
"We are very much part of the equity cult. It is very important that you get long-term outperformance as long as the risks are not high," said Steve Mingle, group pensions director for the L3 billion Diageo PLC Pension Scheme, Edinburgh. The plan has 90% of its assets in equities, with the balance in cash and some property.
He said the Boots move likely would trigger a greater variety of investment strategies by U.K. pension plans, compared with the "herd instinct" that had characterized U.K. pension plans in the past.
Kevin LeGrand, legal and technical manager for Buck Consultants Ltd., London, said there were unique aspects to the Boots pension plan that allowed it to adopt its radical strategy. The plan is relatively small compared with the market capitalization of the plan sponsor, and was well funded - 138%, according to Minimum Funding Requirement calculations.
What is unusual, however, is that the defined benefit plan is open to new members and has around 50% of its members in active service, according to the company. The most obvious candidates to invest 100% of assets in fixed income would be very mature pension plans that were closed to new members, according to Morgan Stanley's Mr. Derbyshire.
"What they are doing is buying a nice stable set of financial figures and stability for the company in terms of contribution rates," said Mr. LeGrand. The short-term cost of their strategy, however, is that Boots might have to make immediate contributions to the plan, as current liabilities are likely to be valued at a lower rate of return than previously had been the case.