Lessons from FRS17 Disclosures

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Is Pension Fund Asset Allocation Really Determined by Fundamentals? Mike Orszag W W W . W A T S O N W Y A T T . C O M Paris, April 2, 2004 Key Question z Do pension funds make asset allocation decisions based on corporate finance risk considerations? z Factors which might matter: – Size of pension scheme relative to company – Size of deficits relative to company – Maturity of scheme

Copyright © Watson Wyatt Worldwide. All rights reserved. Data z UK listed companies have had to report pension liabilities on FRS17 basis since late 2001 z Collected roughly 150 data items for FTSE350 on corporate finance from FRS17 disclosures z Matched data to other data on market returns/option price data, betas, etc.

Copyright © Watson Wyatt Worldwide. All rights reserved. Accounting Dates z Roughly 48% of FTSE350 (168 companies) use Dec. 31 as end of year, 17% (60 companies) use 31 March, 8% (29 companies) use 30 September, remainder use a variety of dates z Define a panel with two waves: – 2001 Wave = Accounting dates between 30 June 2001 and 29 June 2002 – 2002 Wave = Accounting dates between 30 June 2002 and 29 June 2003

2001 2002 Wave 2002 has 5% -30% -48.1% only 10 10% -24.9% -43.7% companies with 25% -15.2% -34.0% surpluses as 50% -7.7% -27.4% opposed to 81 in 2001. 75% 3.3% -17.3% Among FTSE 90% 15.5% -8.3% 100, wave 2001 95% 21.8% -1.0% has only 4 companies in surplus as N 242 257 opposed to 46 in 2001

Percentiles 10 t

1% .169485 n e

5% .3179815 rc 10% .4089045 Obs 254 Pe 25% .5425532 5 50% .6640593 Mean .6343839 75% .755668

90% .8119375 Variance .0278154 0 0 .2 .4 .6 .8 1 95% .8623853 Skewness -.7325749 Equity share of total assets 99% .9631634 Kurtosis 3.641208

FTSE 350: 2002

FTSE100 slightly lower median, lower mean

Variation in equity share between 2001 and 2002 (FTSE 350) 15

Percentiles 1% -.335226 5% -.1859357 10 10% -.1400082 Obs 231

25% -.0830409 Sum of Wgt. 231 ent c r

e 50% -.046847 Mean -.0529932 P

Std. Dev. .0893082 5 75% -.0134888 90% .0074313 . 95% .0304655 99% .1343837 0 -.2 -.1 0 .1 .2 Change in Equity Allocation

Slightly bigger drop among FTSE100

Pension Risk

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Pension Risk

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Regression for Change in Equity Allocation

Changes in Equity Allocation of Pension Funds Lag BS1 -0.008 (0.67) .5 Lag BS7 0.109 (2.85)** ftse100 -0.028

q (2.24)* e f f 0

di Lag PL1 -0.004 (0.93) Constant -0.026 (2.43)* Observations 229 5 -. R-squared 0.05 -.6 -.4 -.2 0 .2 .4 bs7 Absolute value of t statistics in parentheses bandwidth = .8 •significant at 5%; ** significant at 1% BS7 is not statistically significant if robust regression methods are used.