Eye of the beholder


Kevin Murphy

Kevin Murphy

Fund Manager, Equity Value

Once upon a time, not so long ago, final salary pension schemes were seen as sexy. That may sound an odd thing to say about the pot of assets a company holds to pay its pensioners yet, in 2007, large schemes were seen as so attractive entire companies - particularly those with projected shortfalls or 'deficits', such as technology services provider Telent - were bought just so an investment manager could run those pots of assets.

But the future is uncertain and even the grey world of the pension fund is not immune from changing trends. The last few years have not been kind to pension fund deficits, which are now viewed in much the same way as stonewashed denim.

Why has this happened? Every few years companies have to try and quantify the state of their pension fund. The asset side is relatively straightforward - it is just the market value of everything the scheme owns. The liabilities, what a scheme will ultimately pay out, is trickier, however, as it does not know how long its pensioners will live, or future rates of inflation. Working out what the ultimate liability is worth in today’s money - the 'discount rate' - is extremely difficult.

Asset returns have failed to meet expectations, people are living longer, inflation is higher and discount rates have declined with bond yields, all of which mean liabilities have increased significantly. Indeed, after so much bad news, sandwich and salad maker unit last year effectively threw in the towel - it transferred 90% of its shares to its own pension scheme, reasoning the company was essentially being run for the benefit of the scheme so the scheme may as well own all the shares.

But while the situation appears bleak for companies with pension scheme shortfalls today, there are some rays of sun on the horizon. It would not take much for things to turn around and so, as we have noted before, value investors should continually be asking themselves the question, "what if?"

As it happens, recent corporate results have revealed what may just prove to be the start of a long period of favourable adjustment. Recent legislation to change the way pension scheme liabilities are affected by inflation has been the first positive change for pension fund deficits in a long time.

The move - indexing against the consumer prices index as opposed to the retail price index - effectively means schemes will have to factor in paying their pensioners slightly less in future. In the most recent results season, we have already seen the beneficial effects this has had for companies where deficits have been a major concern, including BT, Taylor Wimpey and trinity mirror.

Furthermore, while bond rates - the discount rate used by trustees to value pension scheme liabilities in today's money - have been expensive for some time, should they normalise over the next few years, schemes that have retained a weighting to equities will very quickly move into surplus.

As such, while 18 months ago, corporate analysts were circulating lists of the biggest pension fund deficits as companies to avoid, in the not too distant future they could be sending around those same lists as potential investment opportunities.

The stockmarket will once again have gone full circle, from euphoria to panic and back again, within the space of a couple of years. Instead of being surprised and reacting emotionally, all investors would do better to open their minds to the possibilities of 'what if?' – Although they should probably leave those stonewashed jeans at the back of the wardrobe.



Kevin Murphy

Kevin Murphy

Fund Manager, Equity Value

I joined Schroders in 2000 as an equity analyst with a focus on construction and building materials.  In 2006, Nick Kirrage and I took over management of a fund that seeks to identify and exploit deeply out of favour investment opportunities. In 2010, Nick and I also took over management of the team's flagship UK value fund seeking to offer income and capital growth.

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The views and opinions displayed are those of Nick Kirrage, Andrew Lyddon, Kevin Murphy, Andrew Williams, Andrew Evans, Simon Adler, Juan Torres Rodriguez, Liam Nunn, Vera German and Roberta Barr, members of the Schroder Global Value Equity Team (the Value Perspective Team), and other independent commentators where stated.

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