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SCMP Reporter

A FRISSON of alarm passed through the market last week with the publication of a report by actuarial consultant Wyatt, showing that annualised returns of retirement schemes had not matched rises in the Hang Seng index over the last six years.

  Worse, annualised returns from retirement funds also failed to beat inflation last year and wage inflation over the last four.

  That's bad news for employers, who might have to top up retirement funds should the trend continue.

  And employees could suffer too if a company has a defined contribution plan where a pay-out is partially dependent on investment returns.

  When it comes to retirement schemes, many employees live in a state of blissful ignorance. Ignorance, that is, until the payment on retirement or leaving the firm doesn't match up to expectations.

  Briefly, there are two types of schemes: a defined contribution plan and a final salary plan. A defined contribution plan receives contributions from the employer, plus any added investment income. If investments are poor, the employee will not benefit as much.

  Under the final salary plan, the amount owed to the employee is predetermined as a percentage of salary. Any fluctuation in investments will not directly affect the payout. The smaller companies tend to use the contribution scheme, and the larger the final salary scheme.

  The effect of the present gap between annualised returns from retirement funds and wage increases could potentially be a concern to employees regardless of the scheme the employer chooses to implement.

  Wyatt points out that in the last four years the median annualised return (yields plus capital appreciation) among the 221 funds they surveyed is 9.2 per cent against a wage inflation of 13.2 per cent.

  Wyatt's Mr Danny Quant suggests that funds with managers who have been prudent with the surplus from the mid-1980s should be all right.

  Figures support his assumption. The median for annualised returns in funds surveyed by Wyatt is 16.5 per cent per annum. That figure compares against wage inflation of 11.2 per cent.

  The cushion is ample, even luxurious. It is only in the last four years that annualised returns have given fund managers reason to be concerned.

  Some fund managers will say wage inflation is no way to measure a fund. Although perhaps adequate in measuring liabilities, setting wage increases against annualised returns does not compare like with like. One measures assets, the other looks at liability.

  One fund manager suggests a better base from which one could begin would be Treasury bills. Any investor would be upset if returns were not better than the ball-park figure of seven per cent, he suggested. But with inflation around 10 per cent, such a strategy would not only prove overly cautious, but insufficient in Hongkong. ''Obviously,'' he conceded, ''one would need to go into shares.''   Herein lies the crux of the problem. The best measure of growth in Hongkong is the Hang Seng index, but the index does not adequately reflect the diversity of the retirement scheme portfolios.

  Any portfolio based solely on equity and limited to one region is too risky, particularly with regard to the more long-term retirement fund which, by its nature, has to be conservative.

  ''Putting all their money in Hongkong would be tantamount to putting all their eggs in one basket,'' said Mr Quant. ''You need diversity between equities and bonds.''   At present, the average fund in the Wyatt survey maintains a breakdown of 74 per cent equities, 19 per cent fixed interest, and the rest in cash. These are spread worldwide. A logical alternative, therefore, would be to use a combination of indexes to monitor fund returns.

  One strategy would be to compare performance with the Morgan Stanley World Index. In 1992, for example, the Morgan Stanley World Index showed a return of -7.14. This figure indicates that the world equity market underperformed the Hongkong market by a very wide margin. Not surprising in view of the fact that Hongkong only has a 1.8 per cent weighting in the index.

  Other fund managers suggest a combination: the Salomon World Bond Index with the Morgan Stanley. Although more complicated, the breakdown is more realistic, but difficult for anyone other than a fund manager to devise or follow.

  But regardless of the benchmark, increases in wage salaries have not been matching annualised returns in the last few years. With the rate at which the Hongkong economy has been growing, the gap is hard to close, particularly if the fund has to lean on the side of caution.

  ''The question is,'' said Mr Quant, ''should managers, by recognising that the salary inflation in Hongkong is a function of the economy which is growing very rapidly, [place more] assets in Southeast Asia?''   The trend in the United States and the United Kingdom is just that: invest more locally. In Hongkong, the same is not true. ''If you look at the US or UK pension funds, a huge proportion are in their local markets,'' said Mr Quant.

  According to merchant bank Warburg's research, an estimated 20 per cent of pension funds is placed abroad. For US pension funds, that figure drops to about 10 per cent.

  According to Wyatt's data, the combined Hongkong-US dollar content of the average retirement plan was about 60 per cent after 1985; the pure Hongkong dollar content was somewhere between 20 and 25 per cent until 1991. In 1992 that figure rose to about 40per cent.

  Part of the discrepancy between the markets is accounted for by the lack of securities available in the Hongkong market, which invariably limit the potential size of the investment. The other issue is one of volatility and political risk; both hover overthe Hongkong market.

  As a result of these uncertainties, fund managers look elsewhere. The sort of yields in US treasuries do not match Hongkong's inflation rate, so eventually, the fund manager looks even further afield. Said Mr Quant, ''The trend has been to go into Europebut the market has not been doing as well.''   In comes Southeast Asia, but here size becomes an impediment. ''The size of the market tends to fall away quite rapidly after Hongkong,'' said Mr Stan Vyne, an actuary at HSBC Life. He added: ''Doing fully 10 per cent outside Hongkong [into Southeast Asia] itself is a bit of a risk.''   Mr Vyne suggested the markets would have to develop further before any noticeable shift occurred in funds moving toward Southeast Asia.

 In the meantime, it's a game of waiting for the employee. The question is whether growth will slow and the gap narrow in time to avoid topping up reserves, or whether fund managers will have to readjust their strategies and look more toward Southeast Asia. The answer could be all three, but as Mr Vyner suggests of the course of the economy, ''one would be a fool to predict''.



How should pension funds be measured?