Peering at Eton’s £100mn bet

Receive free Workplace pensions updates

We’ll send you a myFT Daily Digest email rounding up the latest Workplace pensions news every morning.

John Ralfe is an independent pension consultant.

Eton College — Britain’s most famous “public” school — has educated 20 prime ministers, plus more than its fair share of princes, aristocrats, murderers and traitors.

It charges an eye-watering average of £46,000 a year for full boarding, a figure which has come under scrutiny as the Labour party draws up plans to add VAT to private school fees (even though it has backed-off from removing their charitable status).

This very British row — with prime minister Rishi Sunak describing it as an attack on the “hardworking aspiration of millions” — is as good an excuse as any to write about Eton’s financial set-up.

As well as annual fee income, Eton has huge investments in securities and property — £568mn at August 2022 — chipping in handy amounts each year, tax-free thanks to its charitable status. Around 40 per cent of the securities are in private equity and private debt, spread among 30 managers.

The investments — much of them from bequests and donations — go back to Eton’s foundation by Henry VI in 1440, and are much bigger than any other public school. Winchester College (Sunak’s alma mater) has £320mn, and Charterhouse (Chancellor Jeremy Hunt’s alma mater) just £23mn

But Eton’s investment portfolio isn’t just down to generous bequests and tax-free investment performance over many generations. It is also down to Eton borrowing £60mn in two private placements.

In 2015, Eton borrowed £45mn for 45 years at a 3.68 per cent fixed interest rate, around 1 per cent over gilts. This wasn’t spent on scholarships, or maintaining ancient buildings, but “used to leverage the securities portfolio” as the 2019 annual report says (on p39).

In 2019, Eton borrowed another £15mn for 45 years at 2.61 per cent fixed, again around 1 per cent over gilts, with this round “used to leverage the property portfolio” (again, p39).

Despite the coy talk of “leveraging the portfolio”, Eton is taking an explicit £60mn bet that its investments will earn more over 45 years than the interest rates it is paying.

We know Eton’s charitable status gives it significant tax breaks. Perhaps its governing body of 14 uber-distinguished people led by (Old Etonian) Lord Waldegrave — paid £135,000 for his role as Provost — would publish the financial analysis leading it to make this bet, which has been subsidised by taxpayers?

The Provost and Fellows were no doubt persuaded by a combination of arm-waving appeals to “common sense” and analysis of past performance that its investments would, almost certainly, produce more than gilts plus 1 per cent over 45 years (by which point many Fellows will presumably be long gone).

But is this such a sure-fire bet?

Did anyone ask how much it would cost to ensure that Eton couldn’t lose, so its investments would be guaranteed to produce at least gilts plus 1 per cent over 45 years, with upside potential?

Insurance against equity underperformance can be bought — a put option on a stock market index, the right to sell at a set price on a set date in the future. Equity risk should be measured as the cost of buying insurance with an equity put option. And if Eton is taking such a sure-fire bet, then the cost of equity put insurance should be low.

But the cost to insure a return of gilts plus 1 per cent over 45 years is at least 35 per cent, so Eton would have to pay £20mn of its total £60mn borrowing as an insurance premium.

Measuring equity risk by looking at the cost of equity put options also applies to individual pension investors, who may be persuaded that risk reduces the longer the time period. If so, then the cost of buying put options should fall, but in truth the cost increases the longer the option period.

Eton’s £60mn bet — borrowing to buy securities and property — is at least honest and open, more than can be said for defined benefit pension schemes holding equities. For decades companies have used the equity “long-term free lunch” argument to justify holding equities in their pension schemes, even though pension liabilities are like bonds, promising a guaranteed pension, regardless of how assets actually perform.

And most personal pension advice assumes equity risk is vanishingly small over very long periods. We should be clear that expected long-term outperformance of equities is not a reward for patience or a “loyalty bonus”, it is just a reward for risk.

Eton’s own teachers — or “beaks” — are in the public sector Teachers’ Pension Scheme (why private schoolteachers are eligible for public-sector pensions is another story).

Support staff employed before 2006 are in Eton’s own defined benefit scheme. At August 2022, this had £44mn of assets to pay £56mn of pension liabilities — a £12mn deficit, as well as £3mn unfunded to some other ex-staff. Of those pension assets, 98 per cent are held in “Target Return Funds” — hedge funds — rather than long dated index-linked bonds to match pension payments.

This means Eton is not only betting £60mn through private placements, it is also betting £44mn in its pension scheme, over £100mn in total. This is a big percentage of its £568mn investments, especially since most of them can’t be spent under the terms of the bequests.

Is this £100mn bet something that even Flash Harry of St Trinian’s — the second-most-famous English public school — would be wary of?