BP plan won't abandon equity market

While many European corporate pension plans are moving into bonds and alternatives to reduce volatility in their funding levels, BP PLC's £12.7 billion ($21.1 billion) pension fund is sticking with its 75% equity allocation.

That's because the strength of BP's business — and its covenant with the pension fund — allow for such a lofty equity allocation, said Sally Bridgeland, CEO of BP Pension Trustees Ltd., London, which oversees the fund.

“You can't just look at pension funding in isolation. You have to look” at the company's ability to support the fund, Ms. Bridgeland said in a recent interview. “The important thing is to be (emotionally and financially comfortable) with the amount of risk the company is willing to take.”

The trend among European defined benefit funds has been a gradual diversification from equity exposure, especially as mature — and often closed — plans lower the risk in their portfolios, sometimes shifting to liability-driven investments.

In its annual look at aggregate asset allocations among more than 1,000 European pension funds, Mercer found the average equity allocation among U.K. funds fell to 54% as of Dec. 31 from 64% five years ago. The trend away from equities held up in other European market markets, including France, Germany, Netherlands and Spain.

For BP, the covenant — defined as the employer's willingness and ability to pay pension obligations — is at the heart of all pension fund matters at the company, including investments, Ms. Bridgeland said.

BP officials and trustees coordinate the parent's business risks with its pension investment risks, making sure the two don't overlap. For example, fund trustees avoid allocations to emerging markets such as those in the Middle East and South America because the sponsoring company's finances are highly dependent on those regions.

“It's the fiduciary duty of the trustees to diversify, and what we mean is diversification from the covenant, where that's easy to do,” Ms. Bridgeland said.

The BP pension fund is on the forefront of keeping track of the company's health. This year, Ms. Bridgeland implemented a “dashboard” look at the fund's reliance on BP. Combining asset and liability data from consultants Mercer and Hewitt Associates with internal data on BP's corporate financial health, an in-house team runs quarterly “what-if” scenarios for both the fund and the company.

“Most pension funds will, at some level, look at the employer's covenant and at the employer's business risk,” said Craig Gillespie, Reigate, England-based senior investment consultant at Watson Wyatt Worldwide Inc. In the past six months or so, Watson Wyatt introduced a similar modeling tool called covenant asset-liability modeling, or CALM, which three clients are now using, Mr. Gillespie said. He declined to name them.

Among U.S. pension funds, a 75% allocation to stocks would certainly be at the “upper end of the range,” said William A. Schneider, managing director at Chicago-based consultant DiMeo Schneider & Associates LLC. “Plans are generally going the other way” in a desire to take volatility off the balance sheet, he said.

BP's $5.2 billion U.S. plan has an even bigger equity allocation, with 80% in equity, including 20% in private equity.

“Equities are the best diversifier for the company because BP's cash flow is driven by oil prices, and commodities usually have a low or negative correlation to equity markets,” said Gregory T. Williamson, BP's director of trust investments for the Americas.

The company's U.K. pension fund has historically had a high equity allocation, which inflicted less-than-typical damage last year. Returns on investments in 2008 were -17.2%, ahead of BP's custom benchmark return of -19.5%.

Ms. Bridgeland declined to give more recent return data, citing company policy to disclose audited figures only. However, assets increased 9.5% to £12.7 billion as of Sept. 30, from £11.6 billion as of Dec. 31, according to data provided by BP. The company has been on a contribution holiday in 2009. The fund was 106% funded as of Sept. 30, slightly down from 108% funded at the end of 2008.

Private equity buffered returns both on the way down last year and on the way up this year, she said. Private equity can constitute up to 10% of total assets and is considered part of the fund's equity allocation. Other allocations are: 12% U.K. corporate bonds, 5% U.K. real estate, and the rest U.K. government bonds and cash.

Within equities, half are U.K. and half international, which is further split into equal thirds to U.S., European and Asia (including Japan). Private equity doesn't have geographic boundaries, but Ms. Bridgeland said most of those assets are in the U.S. and Europe.

Another reason for sticking with equity is that nearly all of the fund's assets are managed in-house. Ms. Bridgeland says the trustees logically play to her team's strengths, which lie predominantly in stocks.

The fund's in-house team, part of BP's treasury department, lacked corporate bond investing skills, so in 2008 BP hired Baillie Gifford & Co. and Goldman Sachs Asset Management to share equally a £1.5 billion corporate bond allocation — the only externally managed assets at BP.

Similarly, when BP pension executives began investing in private equity in 2002, it first used limited partnerships and funds of funds to tap into outside expertise. As experience and knowledge grew internally, officials started making more direct private equity investments. Now, 60% of private equity investments are direct, although BP still uses funds when entering new markets. Ms. Bridgeland said she hopes to grow internal corporate bond expertise and eventually allocate assets to an internal bond team.

She says the virtues of internal management are many. “Part of it is the comfort you have about having a long-term relationship and long-term thinking with a fund manager,” she said. “It's the ultimate in tailored fund management.” For example, she meets with the head of investment management every other week, something commercial managers can't do because they have too many clients.

There's greater comfort among the investment team, too. “There's a lot of pressure on commercial fund managers,” Ms. Bridgeland said. “Our guys can just focus on managing the money ... which makes life (clear) and straightforward.”