Why bonds are not the answer: John Lewis

Like most defined benefit pension funds, the £2 billion (US$3.27 billion) John Lewis Partnership Pensions Trust is struggling to cope with the funding pressures resulting from the financial crisis. But as pension investment manager Andrew Chapman tells Kristen Paech,
bonds are not the solution.

There’s no denying that defined benefit (DB) funds around the world are currently facing one of the toughest periods in history when it comes to meeting the benefit obligations promised to members.

With heavy losses in investment markets, the funded status of DB funds has taken a big hit, and it will take many years for most funds to return to a funding level deemed to be sufficient by their scheme actuary.

Intuitively, this might prompt DB funds to run for cover and seek respite in lower risk assets such as bonds. Not the John Lewis Partnership Pensions Trust.

Andrew Chapman, pension investment manager at the fund, says the fund, which is the DB fund for England’s largest employee co-operative company, remains heavily invested in equities and is still looking at alternatives, despite the downturn.

“People are scratching their heads wondering what they’re going to do,” he says.

“It’s a one in 1000 year event when liabilities go against you as well as the assets but bonds is not the answer.”

While John Lewis’ allocation to equities has fallen over the last year from 60 per cent to 50 per cent, and the weighting to fixed income has in turn crept up, the fund still only allocates just 15 per cent to bonds.

Some 10 per cent of the fund is invested in property, while the remaining 25 per cent is spread across alternatives including private equity, hedge funds and infrastructure.

“The problem is, if you shy away from risk you end up in index-linked bonds and you never dig yourself out of the hole,” Chapman says.

“Bonds are not an option from that point of view, it doesn’t solve anything.”

The fund’s deficit stood at $1.2 billion at January 31, 2009, up 32 per cent or $288.4 million compared to the previous year.

Chapman says no new asset classes are being considered at the moment, but the fund is keenly watching the infrastructure space with a view to potential further allocations.

“We think we can get a better return from [infrastructure] than bonds,” he says. “Infrastructure is a very attractive asset class. It’s a hybrid between a bond and equity.”

Right now, the fund is looking for income and security, Chapman says, and attempting to strike a balance between risk and return. The entire pension fund is externally managed via 25 managers.

Recently, John Lewis introduced active management to its Asia Pacific equities exposure, an area that had previously been passive.

Chapman says the decision was taken to bring Asia Pacific equities in line with the rest of the pension fund, which adopts active management across most other areas.

“We feel there are extra returns to be had if you pick the right managers, and that’s the key,” he says. “The vast majority of our portfolio is active.”

In November last year, the John Lewis Partnership transferred its 29 per cent share in online supermarket Ocado to its pension fund.

The stake was independently valued at $209.7 million, and was approved by the pension fund after the fund sought external advice.

The company’s annual report for the year ending January 31, 2009 revealed pension cash contributions for the year were $152.7 million, compared to $139.3 million the previous year, reflecting contribution rates agreed following an actuarial valuation on March 31, 2007, together with increased membership of the scheme.