Investors are facing a pensions nightmare
As black hole tops £1trillion, star fund manager Neil Woodford tells the Mail . . .
NEIL Woodford is about to blow the whistle on a huge hidden menace threatening the stock market.
Woodford, one of the UK’s most respected stock pickers, will be the first leading fund manager to speak out on the problem of pension fund black holes.
The investment guru will issue a stark warning on the deficits, which are recently estimated to have topped a combined £1trillion, in his hugely influential blog this week.
In the past few months Woodford has sold a £163m stake in BAE Systems and a £300m holding in BT in his £9.2bn equity income fund, partly because of worries over the shortfalls in their retirement schemes.
He sold a holding in Royal Mail, another company with a big deficit, in January.
So-called ‘defined benefit’ schemes, which pay employees a retirement income linked to their salary, have ‘come unstuck,’ Woodford says.
‘An increasing number of companies face mounting challenges in tackling their pension deficits. At the margin, concerns about their pension deficits have reduced the level of conviction we have in stocks such as Royal Mail, BT and BAE Systems,’ he says. Outsized pension deficits are nothing new. British companies have been afflicted with them for years but only a handful of pensions geeks like me have noticed. It has taken two major
events – Brexit and the fall from grace of Sir Philip Green – to make people pay attention. The row over the £570m black hole in the BHS pension fund, and Green’s responsibility for it, has turned a spotlight on the issue.
As for Brexit, the Bank of England’s knee-jerk response – cutting interest rates and launching more quantitative easing, or money printing – has swelled deficits further.
So should investors follow Woodford’s lead and start being scared about pension shortfalls? In a word: Yes, say experts.
‘How worried should small investors be? Very,’ says Justin Urqhart Stewart of Seven Investment Management.
‘Although we have lived with deficits for a long time, they are potentially very dangerous.’
The facts bear him out. The latest research by experts at Lane Clark and Peacock shows that the combined red ink in the FTSE 100 was £46bn at the end of July.
A study by rival Hymans Roberston suggested that the shortfall across the whole of UK plc has breached the £1trillion barrier. What is going on? People are living longer, so it costs more to pay for their nest-eggs.
And pension funds are an unintended casualty of global efforts to save the financial system from collapse following the credit crisis. The reaction from policymakers – cuts in interest rates and QE – has had a terrible effect on pension funds, causing their deficits to balloon.
The post-Brexit measures from Bank of England governor Mark Carney – which critics believe are an over-reaction – have created more pain.
‘Clearly, the UK’s pension fund deficit has nothing to do with Brexit, it’s been building in the background for years,’ Woodford says.
‘The last lot of QE just doesn’t help,’ says Tracy Blackwell, chief executive of Pensions Insurance Corporation. ‘The Bank doesn’t seem to realise that if companies have to pay more into their pension, it robs them of funds they could have used for productive investment and sets off a vicious circle.’
As deficits swell, companies are struggling to cope. Loss-making state backed bank RBS, for instance, made a record £4.2bn payment into its scheme earlier this year. And if interest rates stay low, there is no relief in sight.
‘Schemes with large deficits can, in extremis, bring down a company and in any case they act as a strain on profits and dividends,’ says City veteran David Buik, an analyst at Panmure Gordon.
PENSION scheme members are likely to face proposals from employers to water down their benefits. A first straw in the wind came when ministers began looking at proposals to allow the £13bn British Steel Pension Scheme to dilute pledges to its 130,000 members.
The idea was to make Tata Steel, which is ultimately owned by an Indian conglomerate, more attractive to potential buyers in the hope of saving British jobs.
‘It could set a terrible precedent,’ says former Pensions Minister Ros Altmann. ‘Many foreign companies have taken over UK firms and they do not feel any real responsibility towards British pensioners.’
Pension costs are indisputably large, but for companies, is it really a case of can’t pay – or is there an element of won’t pay?
FTSE 100 companies paid out billions of pounds more in dividends last year than their combined pension shortfall – money they could have used to plug the gap if they chose.
The situation is complicated by the fact that large amounts of those dividends would have found their way into other pension funds. Even so, it indicates shareholders rank higher than pensioners on the priority list.
So is it a Hobson’s Choice, where companies will be forced to decide between keeping promises to pensioners, or keeping shareholders happy and current employees in work? Actually, no. Pension funds could improve their returns – and the fabric of the nation – by investing more of their members’ money in UK infrastructure and affordable housing rather than just buying bonds.
Schemes should also seek to cut the fees and charges they pay to fund managers and middle men: Railpen, the giant rail workers’ scheme, cut a staggering £100m off its costs after a review.
The Government could help by making it easier for people with small entitlements to be bought out, if they wish. But we need to tackle the crisis now, before it inflicts more harm on shareholders, or pensioners, or both.