Irish equity performance lifts pension funds returns

IT'S that time of year again when the results of the main pension funds are revealed to the public in the shape of the performance figures for the first six months of the year. The results are interesting and show which investment managers have placed their bets most wisely in the first half of the year. However, caution is urged; too much should not be read into short- term performance. Pension fund investment is a marathon race, rather than a sprint and it is long-term performance, five years plus, that counts.

The good news for pension fund investors and trustees is that performance over the past five years has outstripped inflation comfortably. The average annual return has been 12.3 per cent, compared to average annual inflation of 2.3 per cent, according to figures from Mercer and Irish Pensions Trust.

Over the past five years the best performer has been Canada Life. Boosted by a good performance in the earlier years of the period, its managed funds have shown an annual average gain of 13.9 per cent. Standard Life comes in second at 13.3 per cent with Bank of Ireland Asset Management a close third at 13.1 per cent.

The best managed fund-performer over the past three-years - Eagle Star - should not be forgotten. Its funds were not in existence five years ago. Its three year average performance of 17 per cent is well ahead of the nearest competition and the industry average of 12.4 per cent. It also shows the highest return over the past year (27.2 per cent) and the past six months, when its managed fund rose 11.3 per cent against an average of 9.1 per cent. Guardian Life also performed well in the first half of this year with an 11.1 per cent gain while Friends Provident clocked up a 10.4 per cent increase.

The Irish equity market was where funds made most of their gains in the first half of the year. With the ISEQ index rising by 15.6 per cent and big gains among some of the industrial and second line stock, the pension funds gained strongly. Around a quarter of all pension funds assets are invested in Irish equities. However the report on Pension Fund Investment by Deloitte and Touche and Peter Bacon consultants, published last week, identifies this as a danger in the long-term. Specifically the risk for Irish pension funds is that they may have too much money tied up in too few Irish stocks, it believes, and are thus vulnerable to too high a level of investment risk.

Irish employees are likely to become increasingly interested in the performance of their pension funds. The pension funds report notes the increasing number of defined contribution schemes - where the amount the employee and employer pays into the fund is fixed but the pay-out depends on the performance of the fund. Unlike the traditional defined benefit schemes, this means that the employer does not have to pick up the tab if there is not enough to pay a certain pension level.

At the moment over 404.000 employees are covered by defined benefit schemes, with around 73,000 in defined contributions. The report points out most of the newer schemes are defined contributor arrangements. The report notes that as a result of the growing number of defined contributor schemes a more cautious approach will be adopted by pension fund managers in spreading risk and a much greater interest will be taken by employees who are effectively being exposed to the resulting risk.

This is likely to continue to push Irish pension funds into diversifying their portfolios. Already greater freedom to invest overseas has led to much lower holdings of Irish Government gilts by domestic pension funds, but the report points out that the share held in Irish equities has actually increased in recent years. It particularly highlights the exposure of Irish pension funds to the top six companies on the Dublin Stock Exchange, where some 5 per cent of Irish institutional funds are invested. The report says this level of exposure to a limited selection of stocks is too high.

The fund surveys for the first six months of this year points out that Irish funds got a mixed return from overseas investments in the first six months. The report also shows that the strength of the pound relative to currencies such as the dollar and sterling limited gains in Irish pound terms. The British market gained just 3.5 per cent in the first six months, while the Japanese market rose by a modest 1.6 per cent. Continental European markets did better, recording a gain of 8.9 per cent on average. Fixed interest investments meanwhile remain unattractive because of the low level of international interest rates.

The pension funds could thus face a challenge in continuing to record strong investment returns if the Irish equity market fails to show further strong gains. With worries about inflation, Government gilt prices both in Ireland and overseas may remain subdued, while many international markets look fully valued at the moment and perhaps even vulnerable to declines.

From a strategic point of view the pensions fund managers must now plan for the introduction of a single EU currency. This would remove investment risk from Continental EU markets but, if the euro is a strong currency as is promised, then making gains in other world markets will be more difficult as the single currency euro rises against currencies such as sterling and the US dollar.

The good news, of course, is that with wage inflation modest, less growth is needed in fund value to keep pace. However with a relatively low level of state pension provision in Ireland, the impact of an ageing population, and the deficiencies of many Irish occupational schemes, the onus remains on companies and their employees to ensure that their pension schemes are up to scratch.