firms diversifying out of equities to meet solvency requirements may push index even lower
Life companies diversifying out of equities to meet solvency and pension funding requirements could exert further downward pressure on the freefalling FTSE, according to Steven Andrew, an economist at Isis Asset Management.
With the current geopolitical uncertainty seriously diminishing the number of potential buyers of equities, Andrew said, widespread institutional equity selling in direct response to poor markets could create a vicious circle by forcing the FTSE down even further.
'While life offices are attempting to improve their balance sheets by divesting out of equities, they are in fact just locking in their losses,' he added.
The FTSE 100 hit an eight-year low of 3460.3 on 27 January, breaching the previous low of 3500 back in 1995.
Standard Life, rumoured to be a major equity seller at the moment, said it was unwilling to comment on the speculation it is selling down the market. Its last stated asset allocation figures for its £30bn with-profits fund, for the end of the fourth quarter of 2002, shows 55.3% in equities, down from 57.1% at the end of the third quarter.
The group added this is largely due to market fluctuations in equities, down from 73% at the end of the second quarter.
Pension funds under actuarial pressure to sell out of equities because of funding shortfalls caused by market weakness are doing so when the asset class is extremely cheap by historic standards. At the same time, gilts, the most probable source of much of the redirected money, are looking expensive by comparison.
This comes after a report from fund consultant Watson Wyatt suggesting UK pension funds should diversify away from equities into asset classes such as hedge funds, property, high yield and emerging debt.
Global head of investment practice at Watson Wyatt, Roger Unwin, said: 'We recognise diversifying away from equities represents a major policy shift for most funds and will result in much lower risk without giving up too much expected return.'
Eleven consecutive days of decline for the FTSE 100 to 27 January reignited long-running concerns about life office solvency and the health of many defined benefit schemes, despite a slight rally since. From 21 to 28 January, only one company in the All-Share registered a positive return, Man Group with growth of 2.42%.
Three financial companies were in the bottom 10 performers, Abbey National, Amvescap and Royal & Sun Alliance, the latter among the most quoted companies in terms of solvency concerns.
Head of investment at Inscape, John Kelly, said life office solvency is a more relevant issue now than the last time the market was in such a poor position, in 1973-1974, because of the current proliferation of with-profits products offering implicit guarantees.
'With-profits products were very much a 90s phenomenon,' he said. 'Assurance products in the 1970s were much more focused on the insurance rather than the investment element and did not, therefore, depend to such an extent on the health of the company's balance sheet.'
During the 1970s financial crisis, Kelly said, the bear market was so savage many companies were trading below their par value, rendering them unable to raise capital. In many cases, such as when BP was unable to cover its foreign loans, the Government was required to intervene to keep companies afloat.
The increase in minimum AE contributions has had little impact on opt-out rates - with cessations after April increasing by less than two percentage points, data from The Pensions Regulator (TPR) shows.
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