The role of equities is changing in scheme's portfolios. Goodhart Partners' Alan Barlett, Hymans Robertson's Andy Green, JLT's Kieran Harkin, KPMG's Jon Exley and M&G's Aled Smith discuss where value in the asset class can be found.
Andy Green: The role equities provide for defined benefit schemes has not in itself particularly changed, it is just the extent to which they are being used.
The basic requirement of investing in equities is still, fundamentally, to achieve returns. Most DB schemes still have shortfalls, whether they are open to new members – ie they still have plenty of time to actually invest in equities – or whether they are closed funds that are essentially becoming legacy arrangements.
There are two things that are changing in addition to the reduction in exposure to equities. First, most private sector pension funds – and to a much lesser extent local government schemes – are increasingly having to think about the extent to which they are going to become cash flow negative, and equity dividends provide a pretty steady, stable income stream to meet part of that cash flow.
The second is the way in which trustees are looking to invest in equities. Increasingly, trustees are looking at moving away from traditional market cap-based benchmarks with the associated volatility of the market, to seek ways in which they can implement their equity exposure that results in less volatility. This enables them to remain invested in equities, and generate equity-like returns, for longer.
Alan Bartlett: The only real difference is the way people are trying to invest in equities and the sort of structures they employ to try and do that. Ultimately, equities today are the same as equities 10 years and 20 years ago. There is nothing that has fundamentally changed – but we are all trying to sweat money harder nowadays.
Jon Exley: We have actually come a long way in terms of how equities are viewed by pension funds. I remember when equities used to be regarded as the matching asset for pension liabilities and an inflation hedge.
The other issue is that pension funds do not have very long-term horizons any more. The old days, when people would say it was a 40-year play, have long gone.
Most pension funds have probably got a five or even 10-year strategy for getting to some sort of self-sufficiency that would not have equities in there. So equities have to have a shorter-term role than they used to – it is no good just saying that they have got long-term attributes.
I agree with Andy on the income – equities potentially have got two different roles now. One is a ‘me too’ approach, of looking more like bonds and competing with bonds in terms of income – so there is that aspect of equities and you are seeing the appetite for the higher-income ones.
The other role, once you have thrown away all the matching aspects, is just a lottery ticket. Equities are an asset with a lot of convexity that could actually, if you get a very rapid recovery, give you very spectacular returns.
So you have got these two extremes for the role of equities, either as a quasi-matching thing or as something that just gives you this turbo boost to returns in very strong scenarios.
However, we are now a long way away from the old days of equities being the long-term inflation-linked matching asset.
Aled Smith: Not a lot has changed in equities as how it behaves as an asset class. The nature of the psychology of owning equities with individuals and schemes is that after bad periods there is lower ownership and after good periods you find high ownership, and future returns are very correlated to how much people own of the asset class.
The ability for equities to deliver a very long-run return is the bit that might be forgotten in all of this as we try to dissect equities down.
There is a role for something that is a volatile asset class and people understanding that volatility in the long run.
And one should also not forget the regular savers in the equity market, because if you are adding money every single year you get a very different performance to lump-sum investing.
Even in the torrid, so-called ‘lost decade’, if you had put money in every single year, you would have ended up with a pretty decent return, as good as bonds through that period, if not better.
Kieran Harkin: The role of equities is still fundamental to pension schemes, but allocations per se have reduced. So it has had a two-pronged effect really.
Looking at equities traditionally, it is now more subsets and there is more dissection at a portfolio-construction level. But there is also recognition from trustees of the fundamental position that equities can bring to an asset portfolio.
Though we are in a derisking phase, most schemes do not have the ability to take the risk fully off the table. Equities still represent liquidity and still represent strong, long-term growth if you are holding for at least five or 10 years, whereas some of the other asset classes may not give you that shorter to medium-term time horizon.
