UK Royal Mail to make changes
The cult of equity appears to be losing its grip on U.K. pension plans, which are expected to begin substantially increasing and reworking their fixed-income allocations this year.
Anthony Ashton, head of U.K. investment at Hewitt Bacon & Woodrow, London, expects typical fixed-income allocations to double – to between 40% and 50% of plan assets – in the next five years. Currently, U.K. pension plans have fixed-income allocations between 15% and 20% of total assets.
The shift is because U.K. pension plans are increasingly keen to improve the management of liabilities and control investment risks. Demand for fixed-income has increased as a result, he said.
"As exposure to bonds rise, the complexity of bond mandates will also increase," said Nick Watts head of the U.K. Practice at Watson Wyatt Worldwide, Reigate.
Addressing liabilities
The £15.6 billion ($25.5 billion) Royal Mail Pension Plan is poised to enlarge and diversify its £1.7 billion bond portfolio this year, according to Gerry Degaute, chief executive of the Royal Mail Pensions Trustees Ltd., London.
The plan, which covers workers in Britain's postal service, is one of the largest in the United Kingdom.
To date, the Royal Mail plan's bond portfolio has been managed exclusively by Hermes Pensions Management Ltd., London. But the time has come to manage the portfolio more closely in line with the plan's liabilities, said Mr. Degaute.
The Royal Mail plan's liability profile is likely to change significantly over the next few years as the Royal Mail itself is restructured.
Job losses of up to 30,000 people, from a total work force of 220,000, are expected, but at this stage the pension trustees still are trying to get a clear picture of exactly how the redundancies will affect the pension plan, said Mr. Degaute.
In 2000, Mr. Degaute was instrumental in introducing a more risk-controlled approach to the core-satellite strategy for the plan's sizable equity portfolio, which accounts for 80% of plan assets. Property makes up the balance of the plan's investments.
By revamping the equity portfolio in 2000, Mr. Degaute said he hoped to give the plan a greater "risk-controlled investment process," using complementary mandates and less correlated strategies.
And that is his intention with the bond portfolio, although he could not say by how much the plan would reduce its equity exposure. Mr. Degaute also sees the plan's property portfolio as a "good diversifier," and any changes to that portfolio would take place "at the margin," he said.
Once the Royal Mail plan's annual actuarial valuation for the year ended March 31 is completed, he expects to begin an asset-liability study around September. Manager searches are likely to begin toward the end of this year. Fixed-income managers should keep a close eye on developments, as Mr. Degaute expects to give out specialist mandates.
Complementary strategy
"If we increase our allocation to bonds, we will then review if we should put together complementary mandates, rather than more of the same. The larger the asset class, the more likely we are of implementing a strategy of complementary portfolios, as we did with the equity portfolio," he said.
Hermes manages the bond portfolio relatively conservatively, compared with fixed-income strategies being offered by other asset managers, Mr. Degaute added. U.K. government bonds account for 80% of the current portfolio, and U.K. corporate bonds comprise the balance.
Watson Wyatt Worldwide worked on the plan's previous asset-liability study in 1999, and will be helping out this year. The firm is known to be advising its U.K. clients to increase fixed-income allocations and focus on liability management.
Watson Wyatt's Mr. Watts would not comment on the Royal Mail plan but said his firm's larger clients, and those with greater numbers of pensioners, had been gradually increasing their fixed-income allocations over the last few years.
Against a background of maturing plans, greater focus on the financial strength of plan sponsors and new accounting rules, it is not surprising that pension plans are deciding they have too much invested in equities, he said.
Bonds have always been the poor relation for U.K. pension funds. "The primary focus has been on equity, and a lot of attention has been paid to equity managers and their benchmarks," said Hewitt Bacon & Woodrow's Mr. Ashton.
He warns that fixed-income managers need to improve their products to meet the needs of the U.K. market, adding that most still focus on strategies based on peer group and benchmark indexes.
"When the purpose of fixed income changes from being an investment diversifier to being a way to control risks relative to liabilities, then the nature of the mandates have to change," he said.
Mr. Degaute could not give the current funding position of the plan, which is made up of two sections, a closed plan whose members are mostly retired and a plan for active employees. The most up-to-date figures, from March 2001, show the former was 105.5% funded, while the latter was 92.7% funded. Royal Mail increased its contribution rate to make up this gap, he said.
A formal valuation will be published later in the year; the scheme reportedly will face a deficit of £330 million. Mr. Degaute would not comment on this figure.
