Jeremy Warner's Outlook: Markets under the pensions catastrophe cosh

Kirkham's DFS bid

Seemingly endless column inches are devoted daily in the British press to chronicling the growing crisis in occupational pension schemes, yet the truth is that this is a problem that directly affects a comparatively small proportion of the population. Only one in three people are now members of a final-salary pension scheme. This falls to just one in five ignoring the public sector, where there is no crisis - at least as far as the beneficiaries are concerned - because the costs are largely underwritten by the taxpayer on a pay-as-you-go basis.

Seemingly endless column inches are devoted daily in the British press to chronicling the growing crisis in occupational pension schemes, yet the truth is that this is a problem that directly affects a comparatively small proportion of the population. Only one in three people are now members of a final-salary pension scheme. This falls to just one in five ignoring the public sector, where there is no crisis ­ at least as far as the beneficiaries are concerned ­ because the costs are largely underwritten by the taxpayer on a pay-as-you-go basis.

As for the rest, they'll just have to rub along on the basic state pension as supplemented by a means-tested minimum income guarantee, together with whatever they and their employer manage to save into a personal pension or money-purchase scheme, where the size of the pension is defined not by final salary but whatever annuity the saved amount will purchase on retirement. With poor rates of saving, falling returns and growing longevity, this is generally not very much. For huge numbers of such people, there is nothing to have a crisis about. They are already condemned to an old age which in monetary terms at least, will be pretty miserable.

Yet irrelevant though the final-salary pensions crisis may seem to most people, it is unfortunately beginning to affect us all. According to a new study published this week by Stephen Cooper, valuation and accounting analyst at UBS Warburg, the combined pension fund deficit of the FTSE 100 is again rising. At the end of June, it stood at £56.4bn, which is nearly 10 per cent higher than at the start of the year. This is despite the fact that a number of FTSE 100 companies have increased their contributions to their pension funds. With growing longevity and flat equity markets, they are having to run just to stand still.

The upshot is that many companies with final salary pension schemes have decided not to try to plug the deficit at all, but instead are relying on the hope that eventually equity markets will recover sufficiently to do the job for them. Ros Altmann, a pensions economist and governor of the London School of Economics, pointedly describes what's going on as a "pray-as-you-go" system. Any such strategy plainly leaves a lot to chance.

More worrying still, there is perhaps a fatal flaw in the whole approach, for as pension schemes mature, they are forced to dump high-risk equities in favour of low-risk bonds and cash so as to match their liabilities to members approaching retirement. This deepens the deficit in the rest of the fund. It is also generating a steady stream of equity sales, which is severely hampering the recovery in equity markets. If the stock market were to reach a level which completely wiped out the deficit, there would be a veritable tsunami of equity sales, as schemes moved to match long-term liabilities with low-risk assets.

In other words, the big final salary pension funds, once the mainstay of the British stock market, have become its biggest bugbear. This is a problem of all of us, not just those lucky enough to be entitled to a final salary pension. Greater pension fund contributions means lower corporate profits than otherwise, which in turn depresses equity values and further increases the size of the deficits. It also increases the cost of capital to British industry, as those with big pension deficits are charged more for their equity and debt. Meanwhile there's a huge and potentially highly dangerous overhang of unwanted equities which the pension funds threaten to offload whenever the opportunity arises.

Very few final-salary schemes of any size are still routinely open to new employees. Instead, employers are shifting their workers on to defined contribution schemes, where the investment risk of buying equities is borne by the employee. In time, the purchase of equities by defined contribution pension arrangements should begin to outweigh the selling pressure of the maturing final salary schemes. But it could be a long wait. In the meantime, large numbers of people have given up on saving altogether.

The Government bears a substantial part of the blame for this calamity. Abolition of the tax credit on dividends, at an accumulated cost to the pension industry of £40bn, looks with the benefit of hindsight like an act of wanton vandalism. Red tape, new accounting standards and solvency requirements have further undermined the funded pensions sector.

The Government has launched a series of initiatives to restore public trust in the long-term savings industry, which has been badly scarred by scandal and the bear market of the last four years, but most of them have served only to make matters worse by so overloading the industry with regulation and safety first investment rules that all incentive to sell has been removed.

No wonder equities are tanking again. A desperately evil cocktail of influences is at work here, and I begin to despair over whether the underlying value that exists in many areas of the stock market will ever win through again.

Kirkham's DFS bid

There are only three "independent" directors of DFS Furniture, yet based on their slender recommendation, the company now looks set to pass back into the sole ownership of Graham Kirkham and his family. These three musketeers have burned the midnight oil, they've taken advice, they've searched the planet for alternative bidders, they've studied the company's prospects, they've asked Lord Kirkham what he might do if he fails, and lo and behold, they've recommended the chairman's bid, allowing him with some certainty of success to proceed to the expense of making a formal offer.

Admittedly, Lord Kirkham's final bid is quite a bit better than his 415p-a-share opening shot. His second salvo of 435p a share has been further improved by a recent ruling in the House of Lords concerning the payment of VAT on interest-free credit which has allowed him to add another 10p, with the promise that if other pending litigation with Customs & Excise is successful there could be even more to come. None the less, the offer still almost certain undervalues the company.

I say this mainly for the obvious reason that if the founder and executive chairman of DFS is prepared to take the risk of paying 445p a share for the company, then he must think it worth considerably more. But there's plenty of other evidence of a steal in the making. A property revaluation has revealed that the company's freeholds are worth more than double their book value of £68m. By doing a sale and leaseback on these properties, Lord Kirkham can defray nearly a third of his bid costs.

Current trading is predictably said to be "tough", yet despite all the money being invested in driving like-for-like sales growth, the company is still on target to record pre-tax profits this year of £51m. There's not much evidence here of the marked deterioration in prospects hinted at by Lord Kirkham when he first suggested he might bid. To the contrary, the company seems to be doing just fine.

In fact, the "independent" directors seem to have recommended the offer less because they think it fairly values the company than because Lord Kirkham threatened to walk if they didn't. There is no other way of reading their statement which blithely observes that directors have "in particular placed considerable weight on the importance of Graham Kirkham's continued motivation and contribution to the success of the business and have sought assurances from Graham Kirkham as to his intentions in the event that the proposals are not adopted. Graham Kirkham has felt unable to give any such assurances".

This is a shabby end to DFS's 10 years as a public company. Having enjoyed the privileges of the capital markets, taking a very considerable quantity of money out of them along the way, Lord Kirkham is buying his company back on the cheap. The tragedy is that there's no one willing to call his bluff by trying to stop him.

jeremy.warner@independent.co.uk