Top prof – Mike Ostuka

Top prof Mike Otsuka has had enough of his mega pension fund’s investment strategy. In this post he hits out at the USS and calls for members to join him. His article references John Woods’ neglected paper that debunks the investment consultant’s “holy trinity”.

We watch on with interest; here is Mike’s article.

Stocks match pensions liabilities as well as bonds

The Universities Superannuation Scheme (USS) is committed to an expensive, £3.1 bn de-risking of the assets in the pension scheme from stocks (equity) into government bonds (gilts), on the theory that bonds are less risky because the income they generate more closely matches pensions liabilities. According to USS, ‘pensions are similar to inflation-linked bonds, in that the level of payments is pre-determined to be subject to inflationary increases’.

In a recently published article, however, John Woods has argued that, when measured by mean duration, the dividend payments on stocks match pensions liabilities as well as the coupon payments on inflation-linked bonds. He writes:

‘Recognising that an equity can be regarded as an irredeemable bond with a variable coupon … an equity, or a portfolio of equities, has similar characteristics to index–linked [bonds] because there is typically a regular income payment (i.e. a dividend compared with a coupon, both generally paid semi–annually) with a growth component (i.e. a variable rate of dividend growth, compared with a variable rate of inflation). … If duration concepts can be applied to index–linked, we argue that they can also be applied to equities…. At this point, we can appeal to the work of Dechow et al. (2004) and Schröder and Esterer (2012), who have provided a theoretical basis for, and empirical estimates of, equity duration: note, in particular, that their estimates of the mean equity duration were similar to the PPF’s estimate of the mean index–linked gilt duration.’ (‘On the political economy of UK pension scheme regulation’, Cambridge Journal of Economics, 41 (2017), p. 158)

This provides further grounds, beyond those I have discussed here and here, for resisting USS’s Test 1 and its associated gilts-based self-sufficiency valuation.

Too late?

Let’s hope the Trustees have second thoughts and USS puts £3.1bn of the profs’ money into something a little more constructive.

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Mike is a prof at the London School of Economics