INVESTOR PROFILE

BT Pension Scheme digs deep to plug deficit

The £31.3 billion ($51 billion) BT Pension Scheme will make
additional deficit contributions of $862 million per year over the next three years after suffering an $13.6 billion loss on its investments in 2008. Kristen Paech reports on the scheme’s performance in 2008 and its new strategic asset allocation, which includes a 20 per cent weighting to alternatives.

The BT Pension Scheme’s (BTPS) assets reduced by $13.6 billion to $51 billion at the end of 2008, a return of -17.5 per cent, due to the fall in investment markets globally.

Despite the poor absolute return on the overall portfolio, BTPS beat the -19.8 per cent strategic benchmark return, and has achieved average annualised returns of 7.2 per cent per year over the past five years and 4.8 per cent over the past 10 years.

Last year’s performance puts the defined benefit pension scheme slightly behind its peers, with the 50 largest

UK pension funds recording an average investment loss of -17.2 per cent, as calculated by the WM Company.

In the scheme’s 2008 annual report, Rod Kent, chairman of the BTPS trustee board, says investment income is likely to come under pressure this year due to lower interest rates and dividends.

The deficit contributions, which have been approved by the UK Pensions Regulator, will be made in cash, or in specie, and will be in addition to the normal pension contributions, calculated as a percentage of salary, paid by BT.

“We are required to tell members what the implications would be if ever the sponsoring company became insolvent and to estimate the cost of purchasing the benefits from an insurance company,” Kent wrote in his chairman’s statement.

“Without any further contribution from BT the actuary estimated that at the end of 2008 the assets of BTPS would have been enough to provide around 57 per cent of the members’ benefits with an insurance company. However, in the unlikely event that BT became insolvent we believe there are a number of additional protections which may be available to members - the guarantee from the government granted when BT was privatised in 1984 and the Pension Protection Fund the government has established.”

The scheme employs both external funds managers and Hermes Fund Managers, its funds management subsidiary to manage its assets. Hermes Pension Fund Management, is a specialist part of Hermes and gives overall fund advice including strategic asset allocation, and tactical changes.

During the year, the scheme agreed a new strategic asset allocation, most notably an increase in its alternatives
allocation from 13 to 20 per cent.

The fixed interest allocation was increased from 15 to 20 per cent, while equities were reduced from 49 per cent to 33 per cent.

The long-term target for inflation-linked was increased from 10 to 15 per cent, while the target for property was
decreased from 13 to 12 per cent.

The report notes that the scheme’s exposure to equity markets was significantly reduced throughout 2008, as the financial malaise that was triggered by the US housing downturn in late 2007 deepened.

Performance among the scheme’s external fund managers was “mixed”, with the Mercer Large Company fund beating its benchmark by 5.6 per cent while the Schroders Large Company underperformed by 5.7 per cent.

“Against the backdrop of a deepening financial crisis, it is not surprising that government bonds and cash were the
best performing asset classes through 2008,” the report notes.

“However, the Hermes Bonds and Cash portfolios underperformed their benchmarks, driven primarily by the UK Bonds fund which underperformed by 6 per cent due to its overweight exposure to corporate credit. Against a backdrop of a deteriorating UK economy and higher gearing, the UK Hermes property portfolio underperformed by 10.6 per cent.”

The de-risking strategies introduced in October 2007 and increased in early 2008 saw the scheme’s weighting in equities fall from 57 per cent at the end of 2006 to 35 per cent by the end of 2008.

The best performing strategies were the tactical overlay funds, where the risk-rebalance and medium-term asset
allocation portfolios added $2.2 billion and $630 million respectively. These were singled out in the report as the main reason for the scheme’s outperformance against its benchmark.

Despite turbulence in the global commodity markets, the scheme’s commodities portfolios beat their benchmarks, most notably the Global Credit Opportunities portfolio, which outperformed its benchmark by 7.2 per cent.

The trustee established a credit opportunities portfolio in 2008 that aims to exploit specific dislocations that have arisen in the credit market through the current market stresses, initially allocating 3 per cent of scheme assets. The investments have been made using privately mandated funds.

At year-end, BTPS’s investment in hedge funds, through fund of funds vehicles, was $2.2 million. Within this allocation, the Hermes Absolute Return Fund is being partly unwound and replaced with Hermes-BPK Partners Fund.

The scheme’s investments in commodities and private equity were$1.5 billion  and $1.62 billion respectively.

Like many of its peers, BTPS ceased stock lending during 2008, deciding that the added income was insufficient to
compensate for this risk.

Kent says this decision was confirmed in early 2009 and will be reviewed again later in the year.

Fund snapshot:

BT Pension Scheme is a defined benefit pension fund managed and administered by BT Pension Scheme Trustees Limited on behalf of members. Hermes, which is wholly owned by BTPS, is the scheme’s
investment manager and adviser. The scheme had £31.3 billion in net assets at 31 December, 2008, more than 180,000 pensioners, 96,000 deferred members and 63,000 contributing members.

Value of investments (31 December 2008)

Asset class Value(£m) Percentage of fund

Inflation-linked investments                               4.45 14.2

Fixed interest 8.52 27.2

Property 3.48 11.1

UK equities 3.03 9.7

Overseas equities 7.98 25.4

Alternative investments 3.89 12.4

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