Jeremy Warner's Outlook: Cult of equity begins the long march back to favour, but for many it is already too late

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Most investment trends end in tears, tested to destruction by the bandwagon of fashion, yet few are so self-evidently flawed as the present "cult of bonds". This took over where the "cult of equity" left off amid a mad scramble by portfolio managers post the stock market meltdown of 2000-2003 to match future liabilities with what they believed to be more appropriate assets. Equity weightings tumbled, in some cases to zero, as investors opted for the perceived safer option of bonds.

Even today, with the stock market significantly recovered, the newly established cult of bonds continues to bewitch, among trustees, money managers and regulators alike. Why take the risk of equities when you can sleep easy in the knowledge of being safely tucked up in bonds, with certainty of both coupon and capital redemption?

Well, it is obviously a point of view, and in some cases it may even be appropriate. Yet at a time when the Government is being forced to examine a combination of higher taxes, longer working lives and near compulsory saving to deal with the perceived failings of private pension provision, the generalised application of this risk-averse principle looks like an act of almost deliberate destructiveness.

The flight to bonds is regrettably not even a matter of choice in many cases. Rather, it is a switch forced on investors by regulators with newly designed standards for measuring and enforcing solvency. These have required a much more exact matching of current assets with long-term liabilities, making the tried and tested strategy of riding out short-term falls in the stock market much more difficult to sustain.

As recently as January 2004, Standard Life, Europe's largest mutually owned life assurer, was forced by the Financial Services Authority to swap a significant proportion of its with-profits holding of equities into bonds. Admittedly, the timing of this order was not quite as unfortunate as it might have been, for the stock market was already off its worst, but it was quite bad enough. Since then, Standard Life's with-profits policyholders have missed out on more than 25 per cent of upside in the stock market.

For others, it was still worse, with equities dumped wholesale as the market fell, causing a vicious cycle of decline where the more shares that were sold, the lower the prices would go, the more the regulator would require the insurer to sell. Much the same process, though in slightly different guise, has been at work in the balance of pension fund assets.

Are equities really so suspect that like toxic waste they must be jettisoned at every available opportunity? Have we really reached an era when shares are best left to be traded like gambling chips only by hedge funds and other high-risk investors?

New research by Srikant Dash, index strategist at Standard & Poor's, and Kevin Gardiner, head of Global Equity Strategy at HSBC, on the durability of equities goes some way to debunking the new orthodoxy. This finds that most companies are in fact a more reliable form of investment than generally imagined, both in terms of their ability to survive over long periods of time and to keep paying rising dividends.

Indeed, because of improved, generally applied, management techniques, the durability of equities may even be improving. According to Messrs Dash and Gardiner, this makes them a perfectly acceptable alternative to bonds as a matching asset for many long-term liabilities.

Few people with direct experience of the stock market meltdown and the extreme volatility of equity valuations it highlighted, would perhaps recognise these findings. Yet the truth is that if the speculative sectors of technology, media and telecommunications are removed from the index there has scarcely been a bear market at all.

To the contrary, if the S&P 500 is rejigged to give each of its constituents an equal weighting, so that the follies of investment fashion are removed, it today stands at an all-time record, and by some margin too. Volatility in dividends is in any case far less marked.

Many of the deficits in occupational pension funds will eventually disappear of their own volition if left to their own devices. With rising stock markets, they may already be yesterday's story. But not if they are crystallised by an enforced or fashion-driven switch out of equities into bonds.

Just to make matters worse, the newly formed pensions regulator has required all companies to come forward with plans for reducing their pension deficits to zero within 10 years.

In fact, it should be perfectly acceptable for companies to run deficits, indefinitely if they like, provided there is no danger of the sponsoring company going bust. By requiring deficits to be entirely closed, the regulator implies that all such companies will be insolvent in 10 years' time.

We don't need the research of Messrs Dash and Gardiner to tell us this is extraordinarily unlikely. By attempting to limit the risks of failure to virtually zero, the regulator only further undermines what remains of voluntary, private pension provision. Ironically, the pension regulator also makes the risk of insolvency in the sponsoring company that much higher.

By forcing British Airways to address its pension fund deficit, it makes the airline that much less competitive against low cost newcomers and American rivals, many of which have been able to dump their pension obligations on the government backed compensation fund.

The cult of bonds has also led to some highly undesirable, and economically damaging, distortions in the capital markets. As investors swap from shares into debt, it drives down interest rates, enabling private equity, hedge funds, and other leveraged investors to borrow ever more cheaply to buy the equity traditional holders no longer want.

As a consequence there has been a massive transfer of corporate wealth from the many to the few. The stock market has become the preserve of overseas investors, hedge funds and private equity. Well intentioned but misguided regulation has been deeply complicit in this process. No wonder the country needs a brand new pensions system. The old one is being buried alive by an enforced march from productive into uneconomic assets.

United Utilities boss bows out, gracefully

Who said running a utility company is boring? During his 43 years in the business, John Roberts, who yesterday announced his retirement from United Utilities, has seen his fair share of rogues, rascals and downright megalomaniacs.

After beginning life as an apprentice fitter with Manweb aged 17, he finally made it to the chief executive's chair in 1992, only three years later to be pushed off his perch when ScottishPower took the company over. He was then drafted in as chief executive of South Wales Electricity just as it was being swallowed by Welsh Water to create Hyder. The double-headed monster was the brainchild of Wynford Evans and Graham Hawker but within a few short years their national champion had become a basket case.

From there it was on to United Utilities - or Dis-United Utilities as it became known - the product of another spot of empire building, this time in the North-west, where Sir Desmond Pitcher also thought it a good idea to mix water and electricity. Sir Desmond, who came to epitomise the fat cat utility boss of the 1990s, was eventually ousted but not before he had fired the chief executive Brian Staples for running off with the chairman's PA. Mr Staples re-emerged at Amey, but that's another (sorry) tale.

Mr Roberts put the United back into Utilities, sold off the retail electricity supply business and did what utility managers are there for - grind out the cost.

Having persuaded shareholders to cough up for the huge investment programme faced by UU through an innovative two-stage £1bn rights issue, the company has also extracted a decent price control settlement out of the regulators. The only real flop has been telecoms, but then no-one's perfect, and in Philip Green (no not that Philip Green, but the ex-of P&O Nedlloyd Philip Green), the company has chosen a worthy successor.