Equity rools OK

Back in the dog days of the stock market, Boots shifted its pension fund into cash and bonds.

British Telecom stayed in equities.

Now the idea was that when you have long term liabilities such as pensioners - and you can forecast mortality rates, dates of retirement, entitlement, and so on - you should match them with long term assets. Bonds, according to the actuaries, are much easier to forecast than equities since they have a given rate of return to maturity.

Ahem. There are a number of things wrong with that argument. First, there is a risk of default on all corporate bonds and some government bonds. That needs to be allowed for. But secondly, and more importantly, bond prices are not static; they rise and fall in inverse correlation to the yield. There is therefore substantial risk in this market - as some purchasers of bond funds have found when they have indeed received their regular income, but seen their capital shrink.

And finally, of course, bond coupons never grow. Whereas if you buy equities, there is a reasonable expectation that dividends will be increased as the company improves its profitability.

It's that factor that should drive equity prices over the long term. Bond yields can only rise if prices fall - with an equity, both dividends and the share price should increase, if things go right.

So it is perhaps not a surprise that BT, having stayed in equities throughout the last few years, is slowly digging its way out of a pension fund deficit.