Andy Tunningley, Head of UK Strategic Clients at BlackRock, comments on the latest PPF 7800 Index figures: “As the UK’s general election campaign ramps up, it’s easy to feel a sense of déjà vu. In recent years, few things have been more familiar than a UK election or referendum. Sadly, pension fund underperformance is one of them.
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“Even though global equity markets performed strongly during April, UK DB schemes seem to have missed the party again. The PPF 7800 index slid lower from 87% to 86%, as the value of aggregate pension scheme liabilities rose by more than asset values.
The last twelve months have been a political rollercoaster. For schemes that have left a lot of liability risk unhedged, it is likely that their funding levels have been similarly volatile. A string of high profile elections and referendums have gripped bond markets in particular – UK index-linked gilt yields plunged to new lows following the EU Referendum, nominal yields surged higher immediately after the US election, and most recently in Europe, French and German yields have been driven by news flow around the French election. The unpredictable and binary nature of elections are a challenge for investors. In this uncertain environment, we think many schemes should hedge more.
“Beyond politics, economics and wider market sentiment, there is another factor that is central to our view that many schemes are too far underhedged. UK index-linked gilt yields – crucial to determining pension liability values – are driven by a powerful force that is sometimes underappreciated: supply and demand. The proliferation of liability driven investing amongst the pension community has caused demand for linkers to grow at a much faster pace than supply. We estimate that over the next five years demand for index-linked bonds could be around four times the projected supply available to pension schemes. This is an even greater imbalance than that seen in recent years. Even if some of the potential changes to indexation discussed in the recent government pensions green paper were to occur, our estimates suggest there will be a significant supply/demand mismatch in the linker market in the years to come. In our view, this persistent imbalance could act as a powerful anchor preventing a sustained pick-up in yields. Today’s low real yield environment will prevail for some time, meaning that materially better market levels at which to hedge liabilities may not arise any time soon.“
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