Boots investing 100% in bonds – 20 years on
07 Sep 2021
20 years ago, in the Autumn of 2001, the Boots Pension Scheme hit the headlines because it had invested all of its assets in high quality long-dated bonds, selling over £1 billion of equities in the process. I was only three years into my pensions career at the time but I remember being fascinated by this ground-breaking development.
At the time, it was a unique and surprising thing to do, because there was little focus on managing pension scheme investment risk. Indeed, in 2001, pension schemes in the UK invested 75% of their assets in equities (growth-focused, with risk) and less than 20% in bonds (low risk, matching assets). Liability Driven Investment (LDI) strategies were rare and the buy-in market was non-existent, with bulk annuities for pension schemes only being used in situations where the sponsoring employer had become insolvent. This backdrop is why the Boots Pension Scheme’s move to a 100% bond investment strategy really was headline news and there was even criticism from some people in the pensions industry.
Looking back on this today, it’s hard to believe that a pension scheme actively managing down investment risk was headline news. It makes you realise how far defined benefit pension schemes have come in the last 20 years, with all the significant work to manage investment risk to reduce the reliance on sponsoring employer covenants and make members’ benefits more secure.
Today, in almost complete contrast to the position 20 years ago, defined benefit pension schemes in the UK invest 70% of their assets in bonds (low risk, matching assets) and only 20% in equities (growth-focused, with risk). Furthermore, pension scheme LDI strategies are common place and now hedge an impressive £1.5 trillion of interest rate and inflation risks. Cashflow Driven Investment (CDI) strategies, which aim to match the payments a pension scheme expects to make to its members, have taken things a stage further. Further still, the bulk annuity market has taken off since 2007 with around £200 billion of pension scheme liabilities now having been fully insured via buy-ins and buy-outs. In addition, longevity swaps have insured the longevity risk associated with a further £100+ billion liabilities.
In just 20 years, we have gone from a position where a pension scheme deciding to sell its equities and invest only in bonds was headline news, to a position where bonds, and more intricate matching assets, are absolutely the investment of choice and 40% of FTSE100 companies that sponsor defined benefit pension schemes have now even insured a large proportion of their liabilities via buy-ins, buy-outs or longevity swaps. Projected growth in those risk transfer markets means that we expect £1 trillion of defined benefit pension scheme risk to have been insured in 10 years’ time. To put that into context, £1 trillion of insurance would be equivalent to around half of the value of all gilts currently issued by the UK Government or around half the value of all of the companies in the FTSE 100.
All of this is good news for the members of defined benefit pension schemes. Their benefits are now more secure, with less reliance on long-term support from sponsoring employers and I expect this trend to continue at pace. We should be grateful to John Ralfe and others involved with the Boots Pension Scheme in 2001 for having the foresight and courage to lead the way in significantly managing pension scheme risk.
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2 comments on this post
Conversation with James Mullins
Derek Scott
07 Sep 2021
Would James like to estimate how much additional capital from employers has been allocated to DB pensions (instead of business investment and growth) in the form of deficit recovery payments?
To that could be added the additional “normal contributions” for new accrual (until most of the accruals were stopped) based on expected bond rates of return rather than a higher mix of expected returns.
Decomposition analysis, which breaks down the total return on an asset into constituents of income yield, income growth and the revaluation effect, can be used prospectively and retrospectively.
To date, it has been mainly applied retrospectively to equities..
A recent article in Post Keynesian Economics demonstrates, however, that, with appropriate data series, decomposition analysis can be extended to bonds, which means that equity and bond returns and their constituents can now be compared on a like–for–like basis.
Empirical analysis of UK market data since 1976 produces some unexpected results on fixed interest and index-linked gilts: for example, throughout the period, the revaluation effect has been a consistently significant contributor to the total returns of both asset classes and at a much higher average level than that for equities; also, the revaluation effect for index-linked gilts has recently been at an unprecedented level for any asset class.
Seeking to explain them, the article examines the role of regulatory activity, arguing that it has created a dangerous dynamic on unsound foundations.
John Hamilton
09 Sep 2021
I read this sort of thing with despair for the future when it is said with glee to “... put that into context, £1 trillion of insurance would be equivalent to around half of the value of all gilts currently issued by the UK Government or around half the value of all of the companies in the FTSE 100” - yes, in effect this industry has been culpable in the nationalisation by stealth of what hitherto was private DB pension provision. These “de-risked” pensions will have to be paid by future tax payers - that’s what Gilts are - and not from the dividends and growth from private enterprise. Its classic game theory failure - the first one into the liferaft might have a chance, but once everyone had abandoned the ship, it becomes evident to late that the liferaft has no power of its own and can’t carry then to where they want to go.