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Market perceptions can be slow to catch up with reality

The way the state of large company pension schemes tends to be reported is a reminder that investors should consider a business’s financial health through a cycle rather than at peaks and troughs

19/06/2018

Kevin Murphy

Kevin Murphy

Fund Manager, Equity Value

Investors have never had more information at their fingertips than they do today.

And, while that is largely cause for celebration, it does also mean it has never been more important that they tread carefully and think hard about what they do with all that information.

To illustrate the point, let’s pay a quick visit to the world of the corporate pension scheme.

Over the last decade or so, readers of the financial press would have been left in little doubt that those running large company pension schemes were a bunch of baby-eating pirates.

That is not a direct quote, admittedly, but it is the general thrust of headlines, such as the one in the Financial Times in May last year that ran “UK companies pay staff less as they plug pension deficits”.

And indeed the Guardian headline from last August that read “Pension deficit of UK's leading companies equivalent to 70% of their profits”.

And the Telegraph headline from the following month that ominously wondered: “Could big pension deficits endanger your FTSE dividends?” Anyone reading such pieces could certainly be forgiven for thinking twice about investing in a company with a large company pension scheme.

After all, with the perilous state of such schemes draining cash away from the businesses themselves, eating into profits and salaries and threatening shareholder distributions – to the extent that politicians had started muttering darkly that only companies with pension fund surpluses should be allowed to pay dividends – why would you touch them?

Clearly this was not a problem that was going away any time soon …

A turnaround?

So what then to make of headlines last month, such as the one that appeared in City AM? “FTSE 100 pension schemes into surplus for the first time since the crash”, it chirped. Blimey, you might be thinking, that was quick.

And hang on, you might also be thinking, does that mean these companies can now pay out huge dividends?

Well, no – for the simple reason that, just as pension funds of large UK companies were never really in the deficit trouble they appeared to be this time last year, they are also not necessarily in the surplus clover they appear to be today.

What this story really illustrates is how quickly reality can change – and how slow public perception can be to catch up.

Reality can change fast

Acting as the smoke and mirrors is all this is what is known as the ‘discount rate’ – effectively what a pension fund’s ultimate liability to its members is worth in today’s money.

We have discussed this subject in more detail in articles such as Eye of the beholder and Sensational numbers but, put very simplistically, the fortunes of discount rates are inextricably tied to interest rates.

So, when interest rates come down – as they have to an unprecedented level since the financial crisis hit a decade ago – then discount rates also come down and pension fund liabilities rise.

And when interest rates rise – as they are beginning to do in the US and are now expected to in the UK – then discount rates rise and pension fund liabilities fall.

All of a sudden, the outlook appears a whole lot rosier and yet, over the last 10 years and more, the degree to which companies have become any more or less attractive as investments by virtue of their having large pension funds has largely been one of perception.

That is why, here on The Value Perspective, we work hard not to panic when other investors are panicking or grow too excited when others are excited and rely instead on facts and figures – and, importantly, facts and figures that consider valuations through a whole cycle rather than at peaks and troughs. 

Author

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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