“During July, the PPF 7800 aggregate funding level edged up to 89.4% from 89.1%. Have pension schemes done the hard miles and now have the finishing line in their sight? Well, if we learnt one thing from Mo Farah’s epic 10,000 metre performance at the weekend, it is that the last few laps can be the most gruelling…pension schemes would be wise to not let their recent success breed complacency.
“Calm equity markets have helped scheme performance recently. How long will this last? If the summer’s ultra-low volatility environment turns, for how long can pension schemes rely on traditional asset beta returns to protect them from rising liability values? The Bank of England’s recent macroeconomic assessment did not offer many clues. The Bank confirmed its forecast for above target inflation for the next three years but downgraded UK growth for the year ahead. We continue to believe that the uncertainty around the UK’s outlook warrants most pension schemes diversifying equity risk into well selected alternatives, and holding sizeable liability hedging exposure.
“Whilst gilts are the primary hedging asset for most pension schemes, LIBOR interest rate swaps are also common LDI instruments. However, at the end of last month, the death knell was sounded for LIBOR. The Financial Conduct Authority (FCA) announced that panel banks will no longer be compelled to submit LIBOR quotes after 2021. This implies that the LIBOR benchmark may cease to exist in 4-5 years and be replaced by a different risk-free rate.
“It is crucial that schemes do not panic. There are still too many unknowns to justify any significant actions with existing LIBOR swaps. For now, the bottom line is for schemes to not let the LIBOR announcement delay existing de-risking plans – because it may not be necessary or cost-efficient to trade LIBOR swaps as part of upcoming hedge extensions anyway. Based on the current valuation of swaps relative to gilts at longer maturities, most new hedging is likely to be implemented with gilts and gilt derivatives anyway. Schemes should remain vigilant of the developments, but the greatest risk here is that schemes overreact to the LIBOR news, and halt much-needed de-risking. As Mo Farah has proven time and time again, when the finishing line is in sight and things get tough, losing focus is not an option – pension funds should be pushing on to the de-risking finish line.”
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