Company fund switches from equities
Lightning does occasionally strike twice in the same place. For the second time in two years the actions of the WH Smith pension fund have illuminated the relationship between a fund with a deficit and its sponsoring company in a way that makes it a subject not just for aficionados.
Last year, the question of funding the deficit was the rock on which the £940m approach by Permira for the high street newsagent and bookseller foundered. Last month, in a single move, the fund adopted a liability driven investment (LDI) approach that has meant a complete switch out of equities and bonds. Now it is 94 per cent invested in interest- and inflation-hedged instruments, so that the returns should more closely match the payments that the fund will have to make. The remaining 6 per cent is in equity call options to provide some continuing exposure to equity markets and reduce any risk of regret if these markets perform strongly.
The change is driven by a desire to curb volatility and produce a steadier income. It comes with a new agreement between company and trustees that gives the group greater certainty in planning payments to reduce the deficit over the coming years. The £120m cash injection from the sale of publisher Hodder Headline does not do any harm, either.
In its wholehearted embrace of LDI, WH Smith is setting a new course. Specific characteristics have underpinned its approach. The pension fund liabilities were much higher than the company’s market value and the deficit was substantial. Moreover, its pension fund trustees have power both to set contributions and to wind up the scheme, requiring the deficit to be paid. In Martin Taylor, as chairman of the trustees, the fund has someone prepared to use those powers in defence of the pensioners. No doubt this has helped to focus the company’s attention.
Yet these factors would not have been enough to prompt the switch: it required also the availability of more sophisticated LDI products capable of being customised to each fund’s requirements.
Widespread adoption of LDI will depend on more than these products. It would require finance directors and pension fund trustees to look again at their readiness to rely on equities over the long term.
Each fund is, of course, different. But they share a position where the inherent uncertainties from changes in longevity and regulation are such that the idea of reducing investment risk in this way should have broad appeal. At the very least it deserves discussion.
Rip van Somerfield
Yawn. Stretch. “Mmm, that was a good sleep!”
“Rip van Lombard, you’re awake! Thank goodness. You’ve not just been asleep! You’ve been in a coma – for almost seven months; ever since March 24, to be precise. The world has changed a lot: there’s been a general election, which Blair won, oil is above $60 a barrel, and an Australian bank may bid for the Stock Exchange.”
“How fast life moves! And what of my investment in Somerfield? Who won the auction, which began the day I lost consciousness?”
“Strange to relate, Rip, no one has yet taken over Somerfield – though today is the last day under Takeover Panel rules for the final remaining bidder, a consortium including Apax Partners, to put in a formal offer.”
The Somerfield auction seems to have been with us forever. Seven months is a long time for bid uncertainty to hang over a company – eight if you go back to the initial approach from Baugur, which later teamed up with the Apax consortium, only to drop out because of legal problems in Iceland. Why so long?
This was never going to be a quick process, given that it was the first public-to-private deal with up to four separate bidders of varying seriousness. The sheer number of moving parts was bound to slow matters down. And Baugur’s unexpected departure from the Apax consortium in July was disorienting.
The fact this was a property driven transaction, involving a large freehold portfolio, added to the complexity, with, for example, long debates over the conduct of searches.
Given Somerfield’s trading history, the banks backing the buy-outs will have wanted particular reassurance on property valuations and both the line-up of banks and the shape of the Somerfield portfolio have changed over the months.
Somerfield, for its part, was concerned about the leakage of commercially sensitive data to rivals and, in the early days, may not have been as co-operative as it might with requests for information.
Then there was the new pensions regulator, to whom bidders can now apply for clearance before taking over companies with deficits. This was the first public-to-private deal it had faced and it appears to have been learning on the job – though changes in bid financing may also have slowed matters down.
One assumes it will learn lessons and speed up. For managements facing such an unusual combination of bid factors, the lessons may be to assume the road will be long; that it is sensible to co-operate with private equity houses to the extent this makes commercial sense; and that you cannot afford to be distracted from running the business.