“UK pension funds are further than ever from their goals. Deficits continue to swell, as the PPF 7800’s aggregate funding ratio worsened for the fourth month in a row, falling from 79.2% to 76.1%. To compound matters, the goalposts have shifted even further away, as the costs of insuring pension liabilities – already elevated for non-pensioner liabilities - are likely to have risen further given compressed corporate bond spreads. We are a long way away from slow-moving pensions of years gone by, drifting along largely unnoticed. Trustees trying to reach fully funded status are now trying to catch up to a speeding boat while swimming against the tide.
“The return from growth assets in August was no match for ballooning liability values. The key driver of increasing liabilities continues to be gilt yields, which fell materially as the Bank of England cut interest rates and announced a package of new quantitative easing (QE). The cost of buy-out or buy-in is likely to have worsened over the same period, as corporate bond spreads contracted as QE was expanded to include corporate bonds. Inflation expectations also contributed to the increase in liabilities, with UK 10-year breakeven inflation climbing to its highest level in almost one year off the back of the declining pound. Liability hedging strategies are essential to mitigating these key risks – we think most pension funds should be hedging more than their current levels.
“Companies could struggle to make up the pensions shortfall by increasing scheme contributions – as they face the choice of cutting already low capital expenditure, slashing dividends or asking employees to accept benefit cuts – all at a time when UK growth is likely to be challenged. In reality, the onus is likely to be ever more on the funds themselves to manage the risk appropriately – for instance, through defensible allocations to hedging assets - and to find pockets of opportunity, such as the illiquidity premia available through well sourced private market assets.”
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