The revelation that the Church of England is relying almost exclusively on returns from equities to pay vicars’ pensions in the future raises an interesting question: which institutions can afford a sufficient time horizon to be able to rely on the expectation that equities will outperform bonds over the longer term?
I asked Guy Monson, chief investment officer at Sarasin & Partners, this question yesterday and he reckons sovereign wealth funds, endowments, and perhaps family offices are in that position. But he does think some pension funds might start reducing their bond holdings in favour of equities with a bit more of a rebound in the stock market.
However, the Church fund has done things the wrong way round – diving into equities at the top of the market back in the late 1990s. It is certainly unusually committed to the asset class, as many UK defined benefit pension funds have reduced their equity exposure over the past decade, taking the average equity holding to about half of scheme assets last year.
In a letter in today’s Financial Times, Jonathan Spencer, chairman of the Church of England Pensions Board, defends the strategy on the grounds that the fund’s main liabilities “are some way in the future”. However, according to independent pensions expert John Ralfe:
Although the Scheme was set up only in 1998, it is already paying £7.6m pensions a year. Assuming a 5% coupon, it needs to hold £150m bonds just to pay the £7.6m current pensions.
The equity reliance has opened up a big hole in the scheme, which may have to be dealt with partly by cutting benefits.
If only the world were the simple one some pension schemes seem to want to imagine it is, where equities deliver good returns without too much volatility.
In the real world, it does seem that only really long term investors without immediate liabilities can ignore short term volatility and rake in the equity risk premium. Anyone else can be badly hurt by that volatility, which appears to be increasing.
Vicars might do well to reflect that it takes a 100 per cent rise in prices before they get back to the level they were at before a 50 per cent fall. Such miracles do happen, but can they be relied on to pay pensions?