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Bonds Switch Signals End of Cult of Equity

David Oakley, Financial Times
Tuesday, 20 Nov 2012 | 2:10 AM ET

It is a once in a generation moment. For the first time in more than 50 years UK pension funds are holding more bonds than equities.

Some fund managers have called it the death of the "cult of equity" and say it is part of the most significant market allocation trend since the 1950s. The shift to bonds has huge implications for the performance of pension funds and those that manage money for them.

The trend is not limited to the UK. In the US, Europe and Asia, some of the biggest pension funds and asset allocators have been switching into fixed income.

For example, Allianz, the world's second biggest manager of money with about 1.7 trillion euros under management, has only 6 percent of its insurance portfolio in equities while 91 percent are in bonds. A decade ago, 20 percent was in equities.

A pension trustee at a big UK fund says: "We have been switching into fixed income for the past 10 years because of a number of reasons. Since 2002, there have been two stock market crashes, which have shaken equities and makes it difficult for funds like ourselves to deal with the volatility.

"We need stable, fixed returns to match our liabilities and pay our pensioners. There is also growing pressure from regulators to allocate more investments into safer assets such as government bonds."

This switch into bonds because of equity volatility and regulations is known as de-risking and explains the latest data this month from the UK Pensions Regulator, showing defined benefit schemes that guarantee a fixed annual income in retirement are holding more bonds than equities for the first time.

The UK's more than 6,000 defined benefit schemes on average hold 43 percent of their assets in bonds and 38 percent in equities. This reverses a trend set in motion in 1956 by the distinguished fund manager George Ross Goobey, whose landmark speech to pension fund managers encouraged the switch into stocks and out of bonds. Allocation to equities by UK pension funds peaked in 1993 at 81 percent, according to data from UBS Global Asset Management's Pension Fund Indicators report.

Yet, despite the new numbers, some of the world's biggest managers of pension funds reject the claim that equities are on the wane and argue that the trend towards bonds may have run its course and be turning the other way.

Michael Dobson, chief executive of Schroders, whose equities business has halved as a proportion of total assets under management since 1999, says: "I do not believe for one moment that we are seeing the death of equities. Equities are still attractive for many reasons, whether it is yield, risk returns or the fact that some are trading on a cheap basis."

Mr Dobson, who has more than 200 billion pounds under management at Schroders, a large slice of which is pension fund money, adds: "I always think that when people start talking about the death of something, it often means a revival. We could see people starting to switch back into equities."

Indeed, the talk of the death of equity prompted Goldman Sachs to publish an eye-catching report this year, warning against switching into bonds.

"We think it's time to say a long goodbye to bonds and embrace the long good buy for equities as we expect them to embark on an upward trend over the new few years," the bank said, basing its argument on valuations. Compared with bonds, stocks have not looked so cheap for half a century, it said.

Others say the market is not experiencing the death of equity, but an entirely different phenomenon.

John Ralfe, head of Ralfe Consulting, says: "What is described as the death of equities is a symptom of something else.

"The symptom is a change in pension schemes. What we are seeing is not the death of equities but the death of defined benefit pension schemes."

Mr Ralfe, who as chief financial officer at Boots in 2001 switched the company's entire pension portfolio into bonds to reduce risk, singles out the closure of defined benefit schemes as the driver behind flows into fixed income, with a growing proportion of schemes nearing maturity.

This is because managers of mature schemes, or those with an increasing number of members reaching retirement age, need fixed streams of income that are provided by bonds to pay their pensioners.

Alasdair Macdonald, head of investment strategy at consultants Towers Watson, agrees with Mr Ralfe that the closure of defined benefit schemes is forcing pension fund managers into bonds. In the UK, he expects this trend into bonds will last for another 30 years as these schemes continue to mature.

He says pension scheme managers have to play safe and buy bonds as to do otherwise risks company failures and the reneging on commitments to pensioners.

But, even in the UK, the argument may not be as simple as bonds versus equities. Instead, it may be more about getting the right mix of a variety of assets.

Andrew Milligan, head of global strategy at Standard Life Investments, says: "It is no longer a case of do I buy gilts or the FTSE 100.

"That is very old fashioned. You have to look at a whole range of assets from property to emerging markets to exchange traded funds."

Broadly, he says, the pessimists are more likely to skew their portfolios towards bonds as they fear weak growth and possibly recession, while optimists might ratchet up their equity weightings in the hope of recovery.

But, in his opinion, most fund managers will hedge against both scenarios. In an uncertain world, he says, the watchword is diversification.

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