Insurers face £300bn equities question

SHOULD pension funds and long-term savers be invested in equities at all? Millions of savers have hung on through the longest bear market since the Second World War in the hope that the market will recover and reward their faith.

But that faith may prove misplaced. New figures cast doubt on the long-term case for holding shares. Indeed, so severe has this bear market been that we would have been better off in bonds during the past 18 years.

From the start of 1987, the JP Morgan global government bond index has returned 234.4 per cent, compared with a 188.2 per cent return on the MSCI World Equity Index. In the UK, the JP Morgan UK government bond index has returned 447.7 per cent over the same period, compared with a total return of 387.2 per cent from the FTSE All-Share Index.

These figures challenge the reigning orthodoxy that shares provide a better return than bonds over long-term periods - 15 years or more - and that investors are rewarded for the risk that they take with shares.

But retail investors have suffered huge losses in recent years and have already lost faith. And many company pension schemes have been pushed into deficit by the prolonged fall. This has caused firms to close their final salary schemes, while others will have to make substantial cash injections.

Despite the length and severity of the market fall, Standard Life continues to be a strong supporter of equities. The company has come in for criticism for over-investment in the stock market after the latest round of bonus cuts on with profits endowment and pension policies.

That exposure has since been cut back. But Sandy Crombie, Standard Life’s deputy chief executive, is still strongly committed to shares and argues that the riskier bet is not staying with equities now, but jumping off at a point when the market is historically low. Even after the latest bonus cuts, Standard Life, is still paying out higher amounts on its maturing 25-year with-profits policies than most of its rivals: a validation of the company’s strong pro-equity stance in the past.

And the long-term statistics back its case. The latest Global Investment Year Book from the London Business School and ABN Amro shows that, based on stock market behaviour during the past 102 years, there is a 62 per cent probability that this year will be a year of positive real returns and that, again based on previous experience, equities in the long term can be expected to produce a real, after inflation return of about 6.75 per cent a year, beating bonds.

But the issue for investors now is whether this is a "normal" bear market that will see a recovery in due course, or whether we are experiencing a paradigm shift that might see bonds continuing to outperform equities.

This is the 300 billion question for Britain’s insurers - the total amount that they currently have invested in shares.

Many were caught with heavy equity exposures when the market turned. They had been swept up in the competitive performance spiral of the 1990s: the more the market went up, the more pension funds and insurers had to scramble to buy more equities to lift their performance.

Now the reverse is the case: the institutions have been obliged to sell shares at levels far lower than in 2000, either to avoid solvency margin problems or to protect policyholders from further falls (in some cases both).

So should retail investors and pension funds be exposed to equities at all? And, if so, by how much? Is it now more prudent for a pension fund to have the bulk of its assets in bonds and property, with only a residual percentage in equities? Or is the very fact that such questions are being raised symptomatic of the final stages of a bear market and that the shrewd investor should now be a buyer of shares just when the outlook seems so grim? Last week Scottish Widows indicated that it had turned bullish on the market.

And if there is a case for buying, which particular sector or specialism should be favoured? Equity income funds? Value stocks? Growth stocks? Far Eastern markets? Or those heavily depressed and out of favour markets such as Japan?

What is surely vital at this time is that institutions and fund managers have an opportunity to contribute to this debate and make their views known. Over the coming period, The Scotsman will open this column for comments and contributions from Scotland’s fund management industry.

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