FOOL'S EYE VIEW
Boots Sells All Its Shares - Should You?

By Stuart Watson (TMFTiger)
October 29, 2001

Great Titchfield Street, London -- The news that the Boots (LSE: BOOT) pension fund has moved entirely out of shares and into bonds seems to have caused quite a stir. It made this move over the fifteen-month period from April 2000 to July 2001. The obvious question is should other investors follow suit?

Boots Plays It Safe

The Boots fund is what is known as a defined benefit fund. This means a fixed level of contributions are paid in by employees (and usually employers too) and a pension is paid out based on a percentage of each employee's final salary, i.e. what they were earning just before retirement. At its last official valuation (April 2001) the Boots fund was doing quite well. It had £2.29b in assets but it was estimated that it only needed £2.16b to pay out for its pensions. The fund was therefore in surplus.

It appears that the trustees of the fund have decided to play it safe. Based on the current valuation of the fund they calculated that they didn't need the superior growth prospects offered by equities to meet their liabilities. That's all a pension fund such as this sets out to do. Excess returns are a welcome by-product, but the overriding objective is making sure pension obligations are met.

On top of these factors, changes are also being made in the way pension costs are accounted for (due to a new accounting standard called FRS17). Although these changes don't have any cash effect, they do have a cosmetic effect on the financial figures. As the City tends to worry more about image than substance this means that there is an incentive for pension funds to move into lower-risk investments so that, at first sight at least, their numbers look better. 

Should we sell shares?

So back to the original question. Should we, as investors, follow suit? Well, that depends what you are trying to achieve from your investments. If you already have a large amount of money, or you intend to invest a substantial amount, you may not need high returns to meet your objectives. The Boots pension fund is not saying that bonds are better value than equities but merely that they don't need a high return to meet their own particular investment objectives.

Are you in a similar position or are you able to take a long-term view in order to maximise your growth prospects? Security of returns is always one consideration you need to bear in mind. But increased security always comes at the price of lower expected returns. If your expected returns are lower it means you need to invest more to reach the same expected final amount. In its last set of accounts, Boots said it was contributing 10% of salaries each year. Employees are contributing 4.75%. It's also worth noting that the Boots fund sold their shares at higher levels than they are today (possibly as much as 20% higher). They bought their bonds when they were cheaper too. They may not have made the same decision based upon current prices.

What if other funds sell too?

£2.29b may sound like a lot of money. OK, it is a lot of money. But relative to the UK stock market is actually quite small. The top 800 companies on the UK market are worth a collective £1,500b. It's estimated that pension funds own about a third of the UK market. So what if others follow in Boots' footsteps? Will this impact upon share prices?

The answer is undoubtedly yes. However, less and less of a percentage of UK pensions assets are being invested in defined benefit schemes. Defined contribution schemes are not shackled to provide a set amount of money in the same way so it's unlikely they feel the need to make such switches. But if large numbers of defined benefit funds did sell it would soon drive share prices down (and bond prices up) to such levels that the original calculations justifying the switch in the first place became invalid. In fact, at current prices they may already be invalid, depending on the nature of each fund's pension profile.

So it's unclear what other pension funds will do and what impact their actions will have. Selling shares out of fear is therefore a gamble with unknown odds. It makes more sense to continue with your investment plans. Then, if prices do fall, look to take advantage of the bargains that such drops traditionally present.

Where Next? Have a look at our pension centre.