Publications

Bulletin 19 Summer 2001

Myners

The Myners Report - "Institutional Investment in the UK - a Review" was published earlier this year. It contains a list of principles that trustees should set out in their Statement of Investment Principles (SIP), stating whether they comply, and giving reasons for non-compliance.

Whilst no consultation was undertaken on the Report itself, which the Government immediately accepted, comments were sought on the principles. The Treasury is expected to issue revised principles in the autumn. In the first instance, these are intended to be regarded as good practice. However, it has been strongly hinted that, if they are not generally adhered, to legislation may follow.

There are two sets of principles, 10 for defined benefit schemes and 11 for defined contribution schemes. The specific wording is not worth examining at this stage as it may well change, but the general thrust is clear, as follows:

Effective decision-making

Trustees need to be better educated in investment matters and it is good practice to have an investment sub-committee.

Clear Objectives

Investment objectives should take scheme specific factors into account.

Asset allocation

All major asset classes should be considered.

Expert Advice

Contracts for investment advice and for actuarial work should be separate.

Explicit mandates

Investment management agreements should set clear timescales for performance evaluation. Management fees should be inclusive of external research and transaction charges.

Activism

Managers should have a stategy for "shareholder activism".

Benchmarks

Benchmarks should be properly considered and appropriate.

Performance Measurement

This should include "a formal assessment of [the trustees'] own procedures and decisions".

Transparency

A strengthened SIP should include managers' mandates etc.

Regular Reporting

The SIP should be sent annually to all members.

Whilst the principles of trusteeship are independent of the size of the scheme, the practicalities are very different according to the scale of the operation. However, the Report draws no distinctions between small insured schemes, slightly larger schemes in pooled or balanced funds and very large schemes with multiple specialist managers. No concessions are made on grounds of cost compared to expected benefit.

Having said that, much of the content is sound. Indeed, many (particularly larger) schemes will already be abiding by most of the principles, in general terms at least. The devil is in the detail; in particular the strain on schemes/employers imposed by additional costs for little perceived benefits - what are members going to do with a 20 page SIP when it lands on their doormat once a year for example!

Bonds

As schemes have become more mature, they have tended to increase the proportion of their investments held in fixed interest securities. This is to more closely match their increasing pensioner liabilities.

Until recently, portfolios will have comprised holdings of long dated gilts, perhaps including index-linked. Now, holdings will almost certainly include corporate bonds and, perhaps, overseas bonds. These are all new terms, but what do they mean?

Trustees used to listening to their investment managers talking about equities, can be confused by the different jargon. Hopefully the following will help, particularly for those trustees that know that a gilt is a young female pig.

Bond

A fixed income security that pays interest at a pre-determined rate until the bond matures (is repaid). Bonds are referred to by the name of the issuer followed by the coupon and the maturity, eg Treasury 4.25% 2032 has been issued by the British government, pays interest at 4.25% on its nominal value and will be repaid in 2032.

Conventionals

Fixed interest (as opposed to index-linked) guts.

Corporate

A bond issued by a company.

Coupon

The annual rate of interest on the bond, usually paid half yearly. The amounts paid are calculated by applying the coupon to the nominal amount of the bond, not the market value.

Credit

All bonds other than government issues - literally, the credit risk of the borrower.

Credit spread

The yield on a bond in excess of that on a gilt of similar coupon and maturity, also referred to as the margin.

Credit Rating

Bonds are rated by various rating agencies, the best known of which are Moody's and Standard and Poor's. The highest rating is triple A % 2, followed by double A, single A, triple B, double B etc. The UK, US and most major government bonds (apart from Japan) are rated triple A; very few corporates are so highly rated. Bonds rated triple B and above are known as investment grade, those rated below that are known as high yield (or junk).

Duration

The weighted average life of a bond taking into account the receipt of coupons throughout its life and the return of the principal at maturity. It is used as a measure of the volatility of a bond, in other words the extent to which the price will shift for a given change in interest rates.

Gilts

Bonds issued and guaranteed by the UK government. There are both conventional (fixed income) and index-linked gilts.

Gross Redemption Yield

The yield on a bond taking account both of the income to be received (the running yield) and the difference between the market price and the redemption value. For example Treasury 4.25%, 2032 priced at about £90 has a running yield of 4.72%(4.25/0.90 x 100); it has a gross redemption yield of 4.93% (4.72% plus the difference between the price of £90 and the redemption value of £100 or par between now and 2032).

High Yield

Non investment grade bonds rated double B or lower, sometimes referred to as junk bonds. Investors require a higher yield to compensate for the greater risk of default.

Index-Linked

A bond, usually a gilt, where both the coupon and the principal are adjusted for the retail price index (note: adjusted, not increased -in period of deflation the adjustment will be downwards).

Indices

As a benchmark for performance measurement, most pensions schemes will use the FTSE Actuaries series of indices. These are grouped according to the redemption date of the gilts; up to 5 years, 5 to 10 years, 10 to 15 years and over 15 years. There are separate series for conventionals and index-linked. General pension schemes will measure their manager against the 5 to 15 year index (medium dated stocks) or the over 15 year index (long dated stocks) for conventionals; for index-linked the over 5 year index is most commonly used.

Investment Grade

Bonds rated triple B or higher. Historically these bonds have a very low incidence of default. It would be common for investment management agreements to include a requirement that only investment grade bonds may be held.

Maturity

The date at which the bond will be redeemed, usually at par.

Nominal Value

Also referred to as par, this is the unit in which it is traded, usually £100 for a sterling denominated bond.

Principal

A bond is essentially a fixed term loan. The principal is the amount that is borrowed and will need to be repaid.

Redemption Value

The price at which the principal is repaid on the redemption date, usually, but not always, par.

TIPS

Treasury Inflation Protected Securities are the US equivalent of index-linked gilts. They sometimes appear in pension portfolios as they have historically had a higher yield than index-linked gilts.

Yield Curve

A pictorial representation of the level of yields for bonds of all maturities from very short to the longest (usually about 30 years). It is shown as a line on a graph with yield on the vertical axis and maturity dates on the horizontal axis. Traditionally, the yield curve slopes upward -investors require a slightly higher yield for the duration risk of a longer dated bond. The UK yield curve has been downward sloping, or inverted, for some time as a result of increased demand for long dated bonds by pension schemes and insurance companies at a time when the government has not needed to issue any long dated gilts.

Stakeholder

Whilst Stakeholder is strictly an employer issue, one aspect that needs particularly careful attention is the need not to be deemed to be giving advice.

Stakeholder was originally aimed specifically at "the unpensioned", although, following changes in the draft regulations it may now also be used concurrently with an occupational scheme by employees earning less than £30,000 a year.

The regulations provide that employers, in facilitating a stakeholder pension, will not be held responsible for its subsequent performance. But this only holds for "relevant employees" - those for whom it was originally intended, those with no access to an occupational scheme etc.

This exemption from liability does not apply in respect of any other potential buyers - for example AVC holders.

Employers and trustees must be very careful to ensure that communication material is appropriate and must not put themselves in the position of being deemed to have given advice. Just passing on sales material from the chosen provider will almost certainly not suffice. They should also monitor the stakeholder performance as they would that of any other AVO provider. Years on, some stakeholder providers are sure to have performed much worse than others. Make sure you have documentary evidence that makes it clear it was the member's own choice.

Currency Hedging

BESTrustees has recently assisted Record Treasury Management in the production of a currency hedging cd-rom. This is intended to help trustees and pension professionals understand the currency risks inherent in their overseas portfolios and how those risks can be reduced. It really isn't complicated.

Those who attended the NAPF conference and exhibition in Birmingham had the opportunity to see a test version. For a free copy of the cd-rom, email Leslie Hill at lhill@rtml.co.uk or phone Record Treasury Management on 01753-852222.

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