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Not many happy returns

Pension fund managers may now be enjoying their annual bonuses but performance estimates from the WM Company call into question how deserved they are.

According to the WM Company, UK pension fund performance failed to match the FTSE All-Share index in 1997.

UK funds had an average growth of 22 per cent last year compared with the index rise of 23.6 per cent.

In the nine months to September, the average pension fund return from UK equities was 23.9 per cent compared with an index increase of 25.3 per cent. The disparity over the year has increased from the end of the third quarter despite volatility in the last quarter which favours the fund managers.

With non-UK funds included, average performance is estimated to have been 16 per cent last year, equivalent to about 12 per cent without inflation.

In overseas markets, fund managers underperformed the FT/S&P World excluding UK index by six percentage points. The index return was around 18 per cent while the funds&#39 return was 12 per cent.

This was due to fund managers following strategies which looked for a stockmarket correction in the US but missed the volatility in the Far East.

The underperformance can be attributed to two factors – poor asset allocation and stock selection. Fund managers badly misread the overseas markets and failed to take advantage fully of the potential for strong returns in UK equities.

In the UK, fund managers built up their holdings in cash to a record level of £30bn or 6 per cent of total assets.

The high cash holdings were due to fund managers realising equity holdings in strong markets and the exceptionally high number of share buybacks.

Few experts believed that the FTSE 100 would push 5,000 in 1997 and most anticipated a correction.

Britannia Fund Managers outperformed the average, with a return of 17.8 per cent in 1997, and attributes this to not being as bearish as other companies.

Britannia&#39s above-average performance was achieved despite its managers switching their strategy to go overweight in cash, bonds and property in the final quarter.

Head of business development Alistair Sunderland, says: "In September, some managers held 13 per cent cash allocation against an average of 6 per cent. When markets are rising strongly, this is a risky way forward.

"A lot of houses thought they foresaw a crash. This did not happen, despite a dip in October. It will be interesting to see if the fourth quarter is a period of reinvestment."

Managers not only misread the possibility of a correction in the UK but were also biased towards the wrong sectors. Stockmarket growth was narrowly focused on the large stocks, with almost half the growth coming from six stocks in the banking and pharmaceutical sectors.

Financials gave huge returns, far outperforming other stocks, and fund managers which failed to go overweight in banks failed to keep up with the index as a whole.

For example, Lloyds TSB&#39s share price rose by 83 per cent during the year and Glaxo Wellcome was up by almost 52 per cent.

Gartmore and PDFM both underperformed the index. Gartmore&#39s institutional head of business development Ian Martin puts the disappointing year down to an investment policy that was too defensive.

Martin says: "The strength of banks and pharmaceuticals led to a distorted marketplace. As a fund manager, we look for stocks that have high earnings&#39 potential – they end up being middle companies. We do not want to pay too high a price for stock. We believe the UK market is overvalued."

But fund managers also failed to read what would happen in the overseas stockmarkets. They failed to predict the continued growth and potential for strong returns in the US. With most investment houses expecting a correction, managers were vastly underweight in US equities but returns from North America hit a high of 34 per cent.

To have taken full advantage of the US stockmarket rise, a 40 per cent weighting would have been needed while the actual average allocation was around 4 per cent.

Credit Suisse director of institutional pensions Richard Brumby: "There was a view in the US that there was an output gap. The strong economy was expected to break in 1997 after six years of growth. Inflation in the US was a dog that did not bark."

Although managers mis sed out in the US, they did achieve strong results in Europe where returns reached 28 per cent.

With continued earnings&#39 growth and interest-rate convergence in line with the timetable for the introduction of Economic and Monetary Union fund managers had high exposure in index-linked bonds. Although this was defensive, bonds performed well in the final quarter of last year.

While fund managers looked to the US for a correction, they failed to spot the volatility in the Far East. Both Japan and the Pacific excluding Japan produced big negative returns. Japan was down by 19 per cent and the Pacific ex-Japan sector produced a -34 per cent return.

Fund managers which failed to keep track of the index sought solace in the fact that it was by all accounts an unusual year.

But Exeter Fund Management international asset allocation manager Richard Scott says: "This is a bone of contention. Most pension fund managers are looking at average asset allocations, rather than looking at the assets in isolation. Managers shy away from taking exceptional risks. They do not want to be seen to be exceptional or stepp ing away from what is happening generally."

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