“Pension scheme funding remains down in the dumps. After reaching close to record lows in June, the PPF’s aggregate funding ratio plunged even further in July — to 77.4%. The rise in equities over the month was not enough to combat a further drop in already low yields, bringing the index down to its lowest funding level ever.
“The tremors following the UK’s decision to leave the EU continue to be felt. The path of future rates is likely to be even lower for an even longer period, confirmed by the Bank of England’s decision to cut the Bank Rate to 0.25% and indications there could be further cuts to around zero. Recent business activity and sentiment surveys imply that little UK growth is in store for the rest of the year. Covenant risk could increase in this more uncertain environment, with sponsors being less willing or able to increase future scheme contributions. Our long held view is that most schemes should be taking less risk and increasing their liability hedge ratios. We believe that recent political and economic events make this even more critical. Some schemes may believe that better investment conditions could occur in the future, and might be happy to batten down the hatches and de-risk now until the better opportunities to re-invest arise.
“UK pension funds need to think about different solutions to their long-standing problems. Long maturity US investment grade credit represents an attractive proposition within a UK LDI context because it offers higher spreads, increased issuer diversification and asset availability relative to the sterling corporate bond market, with a market that is nine to 10 times larger than its UK counterpart. US interest rate sensitivity can even be converted, via swaps, to GBP rates exposure in order to maintain UK interest rate hedging effectiveness.
“Whether it means further exploring overseas investments, using private market assets to tap into illiquidity premia or using more derivatives to increase liability hedging, it has become clear that UK pension trustees need to think outside of the box to meet their scheme objectives.”
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