Return of the Pension Fund Fudge?

Submitted by Leo Kolivakis, publisher of Pension Pulse.

Tony Tassell of the FT reports on the return of the pension fund fudge:

In
the Hitchhiker’s Guide to the Universe series, the character Zaphod
Beeblebrox wore a nifty pair of “Joo Janta 200 Super-Chromatic Peril
Sensitive Sunglasses”, which had been specially designed to help people
develop a relaxed attitude to danger. At the first hint of trouble they
turned totally black, preventing the wearer from seeing anything that
might alarm.

 

The UK pension industry now seems to want to adopt the accounting equivalent. The National Association of Pension Funds has called for an overhaul of accounting rules
that govern the disclosure of company retirement liabilities, arguing
that these are intellectually flawed and partly to blame for the
widespread closure of schemes.

 

The
move is hugely significant, not only for the UK but around the globe.
The UK led the big revolution in pension fund accounting over the past
10 years to value assets and liabilities of a scheme at a snapshot of
current market values.

 

The
shift under the controversial FRS 17 accounting standard away from a
system of fudging valuations by “smoothing” out market swings led to a
fundamental change in the relationship between companies and their
pension funds.

 

Amid the volatile stock market conditions of the
noughties, it brought home to companies the real risks they were taking
with so-called defined benefit pension funds — schemes where the
retirement income of members is based on a fraction of annual salary
that increases with length of service.

 

The
knock-on effects were far-reaching, triggering the closure of hundreds
of so-called defined benefit pension schemes as companies sought to
stem their losses. It also led to changes in asset allocation, with
funds slashing exposure to equities to invest in bonds that matched
their liabilities.

 

The closure of schemes might have been have
been painful for their members but in many cases it was inevitable
given the scale of risk taken by companies. For some companies, the
size of their pension fund dwarfed their market capitalisation. It was
once reputed that the pension fund of British Airways, at one of the
low points of the carrier on the stock market, could have bought every
share in the airline and still stayed within its guidelines of not
putting 10 per cent of its funds into any single investment.

And
the shift in asset allocation towards bonds sharply reduced the risk
that pension funds fall short of assets to meet their promises to
members.

 

But now the NAPF wants to turn back the tide in an extraordinary reversal.

 

“Current
accounting standards have been very damaging to defined benefit
provision, leading many companies to close their schemes. Pension funds
are long term institutions but today’s accounting standards fail to
reflect this,” said Lindsay Tomlinson, chairman of the NAPF and a
veteran fund management executive at Barclays Global Investors, now
consumed by BlackRock.

 

This is a feeble excuse. Pension funds
might be long-term institutions but long-term is not necessarily less
risky. Just look at equities which have basically done nothing for a
decade after all their swings. Any fund that assumed a positive
long-term return from equities at the height of the dotcom boom would
now be in deep problems, as many funds are.

 

Mr
Tomlinson also offered another justification, by arguing the underlying
assumption of valuing assets and liabilities to market is that markets
are efficient in setting prices.

 

“What I say is that we all know
the efficient market hypothesis is a flawed hypothesis and it is being
talked about in the banking world, too,” he said.

Well that is
slightly curious coming from an executive who has spent a career in the
index-tracking fund management industry. This is business is based on
the idea that active fund management is flawed as markets are largely
efficient and it is difficult to beat them after taking into account
costs.

 

And if markets are inefficient
that only highlights the risks of assuming some kind of long-term
returns to minimise an estimate of current liabilities.

 

What
kind of fudge does the NAPF think should be employed? Or should
investors in companies and members of pension fund just don the Zaphod
Beeblebrox sunglasses and ignore the risks?

Interestingly, the push to overhaul accounting rules comes at a time when European private equity is suffering from a dramatic drop in pension fund commitments: