Every now and then, a decision is taken that well and truly sets the cat among the pigeons. The move by Boots – taken last year although only disclosed in recent weeks – to shift its entire pension fund into AAA-rated bonds is one such decision. The trustees of the £2.3bn scheme did not decide merely to reduce their exposure to equities but to abandon them altogether.
The audacity of the move has left the industry wondering if it heralds a sea-change.
The timing of the decision was auspicious. Not only did it coincide with the court case in which Unilever is suing Merrill Lynch for claiming that it did not meet to meet its contractual fund performance benchmarks but the decision was also taken in advance of a very disappointing year for equity performance.
The question that some are asking – put at its strongest – is whether this could be the end of the post-war equity cult? Already, there are signs that others are following. ICI has moved 70 per cent of its £7bn pension fund out of equities and into bonds.
Clearly, the industry is still digesting the decision and not all commentators agree that it is as momentous as it seems. Winterthur Life pension strategy manager Mike Morrison does not believe it sets a precedent. He suggests that the decision was taken over specific issues affecting the pension fund, such as its surplus, maturity and what future liabilities it has to meet.
The introduction of a new accounting standard for pension costs – FRS17 – is also widely credited for Boots' dramatic decision, despite being downplayed by the company. According to this new rule, any surpluses or shortfalls of the pension fund have to be shown in the company's accounts. Stockmarket volatility can now have a dramatic effect on the balance sheet. The incentive is clear to move into fixedinterest securities and avoid the possibility of a blemish on the company's accounts.
But purely commercial considerations are not allowed to predominate. Under the Pensions Act, trustees are not allowed to be influenced unduly by the company.
Boots has disclosed that the move will lead to a reduction in fund management costs from £10m a year to £250,000.
Of course, risk management was one of the primary factors affecting Boots' decision. Yet commentators are keen to point out that moving entirely into fixed interest does not eliminate risk. Some add that the risk of market fluctuations could be replaced by inflation risk.
As for the performance of equities, most are happy to continue to rely on equities outperforming fixed-interest securities, at least over the medium to long term.
Scottish Life head of pension strategy Steve Bee says: “For a young person investing in a pension scheme, it is high risk not to be in equities.”
Torquil Clark pension development manager Tom Mc-Phail says Boots just got its timing spectacularly right.It has been able to bank its gain and does not need to take any further risk. But clients who want the same lack of risk would have to accept that they will have to pay for this through higher contributions.
Actuary Bucks Consultants legal and technical manager Kevin LeGrand says: “Moving into bonds is not a panacea, especially not at the moment with equities depressed and bonds high. Rep-licating the move now would be cutting out any upside.”
Fund management options are naturally more limited for retail clients compared with the bespoke service offered to institutional clients. Nevertheless, if a client came to an IFA wanting to replicate the move, that would be possible. Skandia head of pension marketing Peter Jordan says his company can offer a choice between 10 different fixed-income funds.
LeGrand points out if the move does herald a fundamental shift – and he is not convinced it does – then the repercussions for the economy could be significant.
Jordan, too, questions the capability of the market to absorb such a basic shift. If the Boots move does mark the beginning of a new trend, there will simply not be enough bonds available.
LeGrand asks: “Will that mean that companies will start to restructure themselves, calling in shares and issuing bonds?” Even a small shift in asset allocation could have a dramatic impact on the economy. According to the National Association of Pension Funds, there is some £700bn tied up in pension funds, with around 50 per cent is in UK equities and 25 per cent in overseas equities. Bonds account for only 12 per cent of the total.
The pressure on bonds and gilts could also have effects on other areas, for example, annuity rates could be depressed yet further.
For John Cowan, independent consultant and former group sales director of soon to be defunct brand Scottish Amicable, there are implications beyond investment decisions and asset allocation.
He suggests that the Boots' decision is an indication that other companies might choose to run down their defined-benefit schemes and that the trend towards defined-contribution schemes will only get stronger.
But above all, Cowan believes that a major decision such as that taken by Boots will lead people to seek out advice, which can only be good for IFAs.