Are any of your stocks weighed down by their pension funds? Hefty shortfalls in can be an investment red flag – and these are the worst offenders
- Companies that have large defined benefit schemes are often on the hook to pay out billions to retirees over time
- Stagecoach, BT and First Group are among the British companies with the largest pension fund deficits relative to their market cap
Company pension funds have hit the headlines once again after Topshop and Burton owner Arcadia slid into administration last week.
Just as with an earlier retail casualty, BHS, a large underfunded pension scheme for the many workers who have had roles at the chains over the decades is a major concern.
Of course, when a company fails its pension fund is bound to run into big trouble.
What is less well known is that even in companies that are fairly healthy and in no danger of going bust, a large pension scheme can be a red flag for investors to take note of.
BT is sometimes dubbed a pension fund with a telecoms company attached
Companies that have large numbers of workers enrolled in defined benefit schemes are often on the hook to pay out billions to retirees over time.
Defined benefit schemes, also known as final salary, are largely a thing of the past for new entrants in the private sector because they oblige a company to pay a certain amount of money to each retiree regardless of how well the company does, or how the investments in the fund perform.
Companies have learnt the hard way that as more and more people retire and live longer these schemes can become very expensive and difficult to honour.
So much so, that some companies such as BT have been uncharitably dubbed ‘pension funds with a company tacked on’, or words to similar effect.
If a company has large pension obligations to fulfil, that naturally limits the amount of money it can pay out to shareholders and invest in its development, so potential investors need to be wary of this.
Simon McGarry, senior equity analyst at Canaccord Genuity Wealth Management and his colleagues have looked across the FTSE 350 and identified the following companies as among the most at risk of their dividends and growth being limited by their pension fund liabilities.
As you can see below BT is in there, along with a host of familiar names as well as one or two you won’t have thought of.
Pension deficits – the worst offenders:
Stagecoach, BT and First Group are among the British companies with the largest pension fund deficits relative to their market cap
McGarry explains: ‘Pension deficits – the gap between what a company needs to pay in pensions to employees and the money available to pay them – can be a good way to test the temperature of stocks.’
‘It’s been a problem that has proliferated since the 80s – as companies with defined pension benefits grew, the number of employees on pension schemes grew too and at some stage, the available money for pension pay outs became disproportionate to what the companies needed to pay.
‘And pension deficits became a thing.’
Low demand: Stagecoach buses parked at a depot
‘As professional investors, they are one of the criteria we look at when we’re road testing the viability of stocks,’ he continued.
‘If the pension deficit looks really hefty compared to market cap, it could well be a red flag. Sometimes it’s a ‘canary in the coalmine’ moment – when we did our pension deficit research in 2017, Carillion came out on top, and we all know how that ended. ‘
‘But usually, it’s not a sign the company is failing – it could be doing brilliantly in growth and revenue terms – but if there is a deficit, there is a liability. And it is obviously more of a red flag when the economy is floundering.’