Fund shocks add to a seismic shift in financial risks

FINANCIAL VIEW
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PETER RODGERS

FINANCIAL VIEW

As investigators search through a maze of detail to find out what happened at Morgan Grenfell Asset Management, the shell-shocked investment industry is coming to terms with the impact on its markets.

Some fund managers were predicting yesterday that sales of all forms of equity and bond investments targeted at the private investor were bound to suffer a serious setback, notwithstanding Deutsche Morgan Grenfell's promise to use its deep pockets to back its erring subsidiary.

There have been plenty of glib explanations of why investors should shrug the scandal off as an aberration, in which the main sufferer is the German bank that owned the firm.

After all, Deutsche has shown that reputation matters and that investors will not be allowed to lose money as a result of malpractice, so the 90,000 affected by Morgan Grenfell's problems have no reason to panic.

Every fund manager in Britain is likely to be checking internal control systems this week to make sure nothing similar happens again. The regulatory rules will also be tightened, with much tougher checks on investment in unlisted securities.

The real significance of the Morgan Grenfell case and the Jardine Fleming scandal a mere four days earlier is nevertheless not the short-term damage to the reputations of the fund managers concerned - which is clearly enormous - but the fact that they come during a seismic shift in the investment industry.

A rapidly accelerating trend from final salary company pensions to group money purchase schemes and personal pensions and tax-sheltered long-term savings such as Peps is creating a huge transfer of investment risk from employers to private investors.

Final salary schemes are those where employers promise to pay a pension as a fixed proportion of salary in the last one to three years of service.

If the pension fund cannot afford to keep the promise, the employer must make good the pension, and thus bears the investment risk if a pension fund does not perform well in the markets.

In money purchase schemes, the employer may put money into the pot, but the value of the pension at the end of a working life is entirely dependent on investment performance. That places the risk of having a poor pension squarely on the private individual, with no back-up guarantee from the company. Personal pensions carry the same risk.

It is true that the equity funds in trouble at Morgan and Fleming were not designed to hold pension money, but were for other shorter-term savings, including Peps. However, these are used by many people as an additional form of investment for retirement.

In any case, equity funds of one sort or another are where the vast bulk of defined contribution and personal pension money goes. The purpose may be different but the investment vehicles are indistinguishable. The distinction will become even more blurred as individuals are given increasing freedom to take their own pension investment decisions.

The two scandals should therefore serve as a sharp reminder that we are moving into a different world, where a majority of people will soon be shouldering responsibility for their own long-term financial futures. Virtually no new final salary schemes are being established, and money purchase schemes are growing rapidly.

Here are some estimates of the growth of money purchase pension schemes from Mercury Asset Management, which last year was ranked as the biggest manager of UK pension funds, with pounds 48.7bn, more than twice as much UK pension business as Morgan and Fleming combined.

MAM has no axe to grind, since although it has attracted pounds 1bn of money purchase pension investments in a drive for new business, this is dwarfed by the conventional final salary schemes that still make up the rest of its UK pension portfolio.

MAM estimates that in the UK as a whole about 10 per cent of the pounds 500bn pot of pension fund money is now in money purchase schemes, much of it with insurance companies rather than City fund managers.

Since many of these money purchase schemes are new and growing more rapidly than older final salary ones, simple arithmetic takes the proportion to 15 per cent in 2000 and 20 per cent in 2005, even if not a single new money purchase scheme starts.

If new schemes continue to be introduced at current rates, this increases to 20 per cent in 2000 and 30 per cent in 2005. But MAM also makes the more aggressive assumption that there will be a domino effect as companies begin to offer money purchase schemes to new employees, or in some cases switch entirely.

Within 10 years money purchase could account for 50 per cent of a pool of pension fund assets that will also have grown considerably from the current pounds 500bn. Indeed, MAM sees signs recently that the domino effect is happening faster than it expected.

The most powerful driving force is simply the attraction for companies of offloading the long-term risk of having to top up a deficient final salary scheme.

There have also been claims that companies are benefiting by reducing their contributions whenever they switch to money purchase schemes, though the most frequently quoted source of this allegation, the actuarial firm Bacon & Woodrow, denies it ever said anything of the sort.

Barclays, Legal & General and Texas Instruments are examples of large companies closing their final salary schemes to new entrants, who are being offered money purchase schemes or group personal pensions. (Morgan Grenfell happens to manage Texas employees' unit-linked investments.)

In another variant, Glaxo Wellcome restricts new entrants to a money purchase scheme but allows them the option to switch to final salary scheme at the age of 40.

There are also advantages for employees, though they are not quite so overwhelming. Younger members of traditional final salary schemes subsidise older colleagues and pensioners but are rarely likely to stay long enough to benefit themselves.

Middle-aged staff of a company that switches from final salary to money purchase pensions may lose out badly, so the young might as well avoid final salary schemes in case that happens to them in the years to come.

And in spite of legislation to set minimum transfer standards, those who leave pension schemes before retirement will be heavily penalised if inflation takes off again at any time during their careers.

Money purchase schemes therefore particularly suit the young, regular job-changers, those on short-term contracts, and those working for weak or small companies where the pension "guarantee" cannot be relied on.

There is certainly a lot to be said for controlling your own pot of money and taking it with you from job to job - but that takes us back to where we started. There is also an extra risk to shoulder.

The forces at work in the marketplace are far too powerful for the scandals to cause more than a blip in the long-term increase in sales of pensions and other investments. What the revelations may actually achieve is an acceleration of the concentration of the industry into a few enormous fund management firms.

The usual reason cited for this consolidation is the way marketing and back office costs are soaring, bringing important economies of scale.

But the speed with which Germany's best-known banking group moved to compensate clients of its UK subsidiary suggests that the real lesson for investors is that the safest place for your money is a firm with very big name behind it, that can afford to pay whatever it costs to protect its reputation.

Top 10 managers of UK pension funds

Funds under

management (pounds bn)

Mercury 48.7

PDFM 44.1

Schroder 37.0

BZW 21.6

Gartmore 17.8

Morgan Grenfell 12.3

NatWest 11.6

Hill Samuel 10.8

Fleming 9.2

Prudential 9.2

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