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When he was governor of the Bank of England, Mervyn King liked to say that central banking should be boring. The accounts of the bank’s £4.4bn pension fund “should be boring too”, says John Footman, chairman of the trustees, in a note to scheme members.
Both men understate the case. For central banks, grappling with the financial crisis followed by historic quantitative easing programmes was anything but dull. The BoE’s pension fund also operates in a dynamic investment world and must contend with enormous increases in its liabilities as members live longer lives.
A decade ago, the BoE’s pension fund switched its investment policy from a mix of gilts and equities to a portfolio exclusively focused on index-linked gilts. The aim was to have, in the modern parlance, a cash-flow matching strategy, and in Mr King’s mind the fund would buy the gilts and stick them under the mattress.
That switch was the fund’s first change in investment policy since it came into being just before the second world war, and until fairly recently has served the scheme well.
But a further symbolic change is coming.
Near the end of the October minutes of the meeting of the Court of Directors, which sets the BoE’s strategy, Mr Footman said “taking more investment risk” and “alternative approaches” were under consideration. The result of that review will not be known until next year as the trustees, and their advisers, consider the suitability of asset classes ranging from corporate bonds and equities to infrastructure and exchanged traded funds.
Baroness Ros Altmann, a former UK pensions minister, says the review is significant.
“It effectively admits that the cost of providing pensions using only index-linked gilts may be too high and that the use of just these gilts may not deliver the most effective asset backing for the liabilities.”
She also argues that pension funds should not be too reliant on fixed-income products, given negative real yields on index-linked gilts.
“These supposedly low-risk assets have lost around 7 per cent in the past year, while other asset classes have performed much better. This significant capital loss is not normally a characteristic of a low-risk or risk-free asset,” she adds.
Most pension funds periodically review investment strategy. But the move by the BoE pension fund is a clear signal that gilts are now relatively less attractive, and also that defined benefit pensions are not necessarily best served by gilts.
Marc Ostwald, a strategist at ADM Investor Services, the broker, says the BoE’s pension fund should not be considered in any way a benchmark for others.
“Like any government department or local government pension fund, it is hostage to whatever the government actuary tells it to do, above all in terms of asset liability matching.”
His view is the fund, which had a £57m surplus and 101 per cent funding level at the end of February, has been an OK performer more through luck than judgment, as the period of super-low bond yields lasted much longer than expected.
“Diversification seems well advised, and one might argue that had the fund been more diversified over the past five years, they may well have performed better,” Mr Ostwald says.
“As rates edge up from their all-time lows, so the need for diversification will becoming more pressing.”
The BoE fund is unlikely to move too far up the risk spectrum, and any changes to its investment mix are likely to be slow and steady.
Even so, the managers of the pension fund, as well as those running the central bank, face a future that surely will be far from boring.
Peter Smith is the editor of FTfm