My blog yesterday on USS attracted a lot of attention on social media and some interesting comment.
This from Ros Altmann – a blog in its own right;
Excellent piece Henry.
There is insufficient differentiation in this DB debate between open and closed schemes and of course the exceptional situation with respect to interest rates that currently prevails.
Long-term investment for long-term liabilities is a prudent approach, as long as the investments and risks are properly understood and managed.
The Bank of England’s pension scheme gives an indication of what has happened if schemes invest wholly in gilts – its pension fund fell into deficit and its contributions had to rise from around 25% to over 50% of staff salary.
This is a live ‘case study’ for those who suggest DB schemes should invest only in ‘safe’ or ‘matching’ assets.
Gilts do not match pension liabilities – they are an approximation. There remains a mis-match as they do not move with longevity, lpi or salary inflation and, of course, if starting from a deficit position then just ‘matching’ is not sufficient anyway.
Outperformance of the liabilities is required. Diversifying sources of risk and return, which can expect to outperform ‘low-risk’ bonds is likely to offer better long-term prospects for USS.
You rightly point this out and I do hope this receives plenty of ‘likes’! Well said Henry.
Anyone who follows my tweets knows that we don’t always agree, this was a welcome point of harmony!
What we are agreeing on is the time horizons of differing types of investors and that there can’t be a one size fits all approach to the way we fund our financial futures.
We can take lessons from history; one lesson is that in the short-term, for instance over the years following the recent financial crisis, bonds can provide a better real return than equities.
But to suggest from this that bonds are better than equities, is to ignore the longer term trend.
I suspect that what lies behind these tweets from well respected investment consultants is an unwillingness to engage in pensions much beyond the end of this decade.
I am not going off on a discourse into the rights and wrongs of debt and equity (when Con Keating gets his internet access back, we can expect to hear from him on that).
But I think the statement that bonds are better for all needs to be challenged.
Investing in a company’s debt, like investing in index-linked debt is to me a misnomer. You are not investing, you are providing finance which is not the same thing. That finance is finite, investing in equity is infinite. Universities, Governments and even some private companies are to me infinite- they have no obvious end.
We have chosen to make some of our pension schemes “finite” with strategies that plan to end the pension scheme in a certain number of years. But we have also agreed that some pension schemes will continue on infinitely – the University Superannuation Scheme is such a scheme.
This concept of an infinite scheme should not frighten us, any more than the state pension should frighten us. We cannot assume that the world comes to an end when we do , this is a very myopic approach! We have to assume that the USS will outlive us and hopefully out live our children.
Bonds have a limited duration
The only thing I would add to Ros’ analysis is that bonds, which are effectively IOUs – demand repayment. At some point the bond comes to an end – it is finite.
If you are invested in bonds – as the Bank of England is and as the old Royal Mail pension scheme is, then you provide very high security for a group of people. The Bank of England have feathered the nest of one group of staff, but another group are now having to pay for the 50% of salary going into the pension scheme. That group has to be those left working at the bank.
Precisely the same thing has happened at the Royal Mail which has secured past benefits but is too finding it will have to pay 50%+ to accrue further – using a bond based strategy,
The Bank of England can of course pay pensions and people as it likes, the Royal Mail can’t. The end result of the Royal Mail’s excursion into the “bonds for all” strategy has been the closure of the scheme and industrial unrest. If this is what the investment consultants call “better for all” , I am glad I am not an investment consultant.
I stand by my tweet.
You cannot own a loan
People talk about owning a debt portfolio but that is nonsense. Owning bonds is not like owning a share of an organisation, you are not the real owner and you have no voting rights.
If you own equity you have a stake and a say in that enterprise. We need people to take the long-term view of ownership so that companies can invest and become more productive.
If ordinary people are going to understand investment, it is not through the bond markets – leave that to the bankers (and the investment consultants).
Pension schemes need to invest in some debt (as Ros points out) but this should be balanced by investment in the long-term future of our companies and our economy, only equities allows us to participate in this long-term growth and that is why over the long-term, equity holders get rewarded by a premium of better returns.
If we are ever to restore confidence in our pensions, we must leave behind the short-term shallow thinking that assumes such rot as that because bonds have returned more than equities over 10 years, they are better all round.
You cannot invest in a bond, you cannot own a bond, you can only benefit from a bond. The ownership and investment opportunities lie with real assets; this is where the majority of USS’ investment fund is invested and where most of us have our pension savings.