Case Study Pension Fund

Question

AONE pension fund has assets of £20m.  Contributions from Lower Valley Estates and the Members of the fund are currently running at approximately £1m pa received at the end of the year whilst dividend and interest income from investments in the current year is estimated to be £1.2m.  Pensioners of the fund absorb £1 m of this income in the current year but this is expected to rise by 10% pa in succeeding years until it reaches a temporary plateau of £2 m.  The fund has four Trustees including the Managing Director, Finance Director and Property Manager of Valley Estates as well as a Trade Union representative.  Advice is provided by a consultant Actuary whilst the day-to-day administration is carried out by a pension fund manager.

Up to the present the investments of the fund have been managed by The Mutual Life Assurance Company (MLA) as part of a larger pension fund unit trust which pursues a contra-cyclical policy.  When the market falls significantly the fund buys; when it rises substantially funds are allowed to accumulate in a variable rate deposit account.  The investments have done well but seldom in line with the index and for this reason the Actuary to the pension fund has arranged a ‘Beauty Parade’ of fund managers enabling other investment managers to explain their investment policy, past performance and future prospects to the Trustees.  MLA has been invited to the Parade and has the opportunity of justifying their charges (0.5% pa of the net asset value of the fund), moderate turnover and predominantly UK orientation.

Investment Managers of Scotland (IMS) offer an ultra conservative investment policy.  Their policy is to concentrate on ‘value’.  Investments decisions are taken on the basis of ‘fundamentals’ and decisions are made by an investment committee (all of whom have First class honours degrees).  IMS offer low management charges. (0.1% of asset value per year) and promise very low turnover (about 10% per year).  Investment is mainly in the UK, US and Japan since the managers feel they should concentrate on areas they know.  Technological growth stocks have been an important area of investment in the past.  The managers are acquainted with the Efficient Market hypothesis and claim that that their approach is sympathetic to the hypothesis although they reject any extreme interpretation of it.  Their competitors, they argue, are generally slow to recognise value, poor at understanding new information on technological developments and deficient in understanding the role of growth and discounting in affecting share values over long periods of time.

Index funds UK (IFU) offer the same performance as the FTSE 100 Index.  They guarantee to provide performance that exactly replicates the Index in both capital gains and monthly dividend yield.  They make no charges for this service but take any returns earned by the pension fund over and above those available from investment in the Index.  Other Index managers, they claim, charge for the service, are generally worse than the index they shadow and offer no guarantees.

Edinburgh Gilt Managers (EGM) offer guaranteed return of 7% pa for the next five years and a ‘reasonably certain’ return of inflation rate + 5% for the foreseeable future.  Charges are 0.25% of the value of assets managed per annum, EFM use advanced portfolio immunisation techniques and make use of a wide range of bond management techniques.  They argue that wealth is destroyed by inflation, that many journal articles reveal that investment in equities is poor protection from inflation and that pensioners have a right to know their funds are totally safe with no market or inflation risk.

Performance guaranteed Managers (PGM) offer high returns based on trading strategies derived from past share price performance and information derived from market traders.  Fees are performance related with a basic charge of 0.1% pa of net asset values and performance charges of 1% of returns over 15%.  The fund has traditionally had a high turnover, a policy which is expected to continue in the future.  PGM point to the success of some mechanical trading rules such as Thomson’s closed-end fund rule and the existence of day of the week, January and other anomalies.  They argue that performance related fees tie the managers’ interests very closely to their client interests.  No performance, (virtually) no fee.  According to PGM Agency problems are a serious concern in Capital Markets.  Inside information will only be used to your advantage if the managers share in the benefits.

Past Returns over the last thirteen years for the Index (FT All Share) and for the investment managers are provided in Tables 1 and 2.  The consulting actuary has calculated risk statistics based on data for the thirteen years except for the betas which have been calculated using data for the longer periods.  These are expected to continue in the future.

You have been retained by the Trade Union to provide advice to their Trustee as to the appropriate investment strategy for the fund.  The Trade Union is particularly worried about accusations of short-termism in investment strategy.  It wants to be seen to be supporting British Industry but at the same time recognises the duty of the Trustee in law and the needs of the current and future Members and Pensioners of the pension fund.  Investment surpluses have traditionally been used by the firm to improve benefits.

The Union expects you to provide a typed report of 1,500 – 2,000 words plus accompanying charts, diagrams and tables.  Their representative is too busy to read any more and will almost certainly discard any excess.  The report should examine the performance claims of the managers and provide risk-adjusted measures which can be used to rank the managers.  The merits of index linking investment whether a stock market index or the rate of inflation should be examined together with an assessment of the managers abilities to meet the current investment objective of the fund which is to be in the top decile of all pension funds whose performance is currently measured by the WM company.  Although performance statistics such as those in Table 1 are provided to the Union representative as an independent verification of those provided by the WM Company the Union is not convinced that they are useful or representative and would like advice on what appropriate comparison standards should be.

The Union also have doubts about suitability and meaning of the pension fund’s objective.  There is currently no formal statement of whether this objective is to be met in each quarterly review or over some longer period, whether it is realistically attainable at all or what account should be taken of risk.  Does a fund gain from international diversification or from investment in gilts?  The possibility also exists for splitting the fund between fund managers.  The cost of such a split would be increased work for trustees and the Fees of all managers except IFU would double.

 

Table 1

Performance Statistics

Year

'British Govt. Securities (20 year) Redemption Yield

FTSE 100 Index

FT All Share

Retail Price Index

1994

 

3,065.5

1,521.4

146.0

1995

8.50%

3,689.3

1,803.1

150.7

1996

8.40%

4,118.5

2,013.7

154.4

1997

7.50%

5,135.5

2,411.0

160.0

1998

7.00%

5,882.6

2,673.9

164.4

1999

5.00%

6,930.2

3,242.1

167.3

2000

4.70%

6,222.5

2,983.8

172.2

2001

4.78%

5,217.4

2,523.9

173.4

2002

4.83%

3,940.4

1,893.7

178.5

2003

4.64%

4,476.9

2,207.4

183.5

2004

4.78%

4,814.3

2,410.8

189.9

2005

4.39%

5,618.8

2,847.0

194.1

2006

4.29%

6,220.8

3,221.4

202.7

2007

4.43%

6,456.9

3,286.7

210.9

2008

3.92%

4,434.2

2,209.3

216.8

 

 

Table 2

Past Performance

Year

MLA

IMS

EGM

PGM

1995

9.0%

12.0%

9.5%

24.5%

1996

9.0%

5.0%

1.0%

15.0%

1997

15.0%

25.0%

9.6%

32.0%

1998

7.0%

12.0%

9.7%

20.0%

1999

17.0%

15.0%

11.1%

10.0%

2000

-2.0%

-4.0%

5.5%

-20.0%

2001

-4.0%

-8.0%

4.8%

-20.0%

2002

-5.0%

-20.0%

4.2%

-35.0%

2003

8.0%

12.0%

5.0%

20.0%

2004

6.1%

8.3%

4.4%

13.0%

2005

11.0%

16.0%

6.1%

26.0%

2006

9.2%

12.9%

5.5%

20.4%

2007

5.2%

5.8%

4.6%

7.0%

2008

-12.0%

-23.9%

-0.1%

-47.7%

Standard Deviation

7.8%

13.5%

3.1%

24.0%

Beta

0.40

0.70

0.10

1.30

 

Arguments or Critical factors analysis about the model’s and results within 8 issues (Please see the course work last 2 paragraphs)

  1. Evaluate the objective and describes the right or not right objective of the Funds.
  2.  Merits and demerits of Index linking Tracker Funds (Tracker Funds performance with FTSE – 100) and use from top deciles (Top Ranking) pension funds.
  3. Protection for the pension funds (Hedge, Not hedge or Perfect hedge) and suggests the best choice of Hedging or the most appropriate means of hedging shares, bonds, and interest.
  4. Examine the advantage of the Pension Funds investment in Bonds, Guilt’s or UK Governments Bonds market. Why?
  5.  Suggest the best and most Suitable “Bench Mark” of the Pension Funds for comparing performance and give reasons for such a choice. Why Bench Mark?
  6. Advantages or Disadvantages of international diversification of the Pension Funds.
  7. Splitting the Funds between the Fund Managers.  Are there any advantages for doing this? (Please calculate also costing).
  8. How regularly or at best periodicity of the performance measurement (Monthly, Quarterly or Yearly)? How often do we measure these fund performances.

Write about the above requirements and attach appendix with all calculation, graphs, and charts.

Summary

This particular question in Finance deals with a pension fund by the name AOne Pension Fund. All the details about the pension fund have been given in the question including financial data and growth index of the fund. The solution provides all the necessary calculations and provides explanation of the results. Please find the Excel sheet attachment for calculations.

Total word count is 1343

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