Pensions - Articles - BlackRock comment on PPF Index Update for March 2017

 Meanwhile, UK real yields were fairly flat, having never reached escape velocity from their post-Brexit lows. The reversal of nominal yields may be a wake-up call to some pension schemes that are counting on rising yields to alleviate their funding woes. Last week’s Spring Budget showed, as was widely anticipated, that the government’s borrowing requirements will be reduced relative to last year. For index-linked gilts, this likely means less supply next year than was previously assumed - which suggests that the supply/demand pressures affecting long-dated linkers, driving by huge pension fund demand for hedging assets, could intensify. For nominal gilts, despite the government’s reduced borrowing requirements, net supply could actually increase in 2017 relative to 2016, given the imminent cessation of the Bank of England’s latest round of Quantitative Easing (QE).
 
 “These moves show how dependent government bond yields are on politics and central bank actions. As the UK prepares to trigger formal notice of leaving the European Union, government bond yields – and hence pension fund liability values - are likely to be ever more difficult to predict. In the uncertain environment that Britain is likely to face in the coming years, we believe that many pension funds – particularly those with sponsors who could do badly from Brexit-led uncertainty – should look to mitigate interest rate and inflation risk. Many pension funds should hedge more interest rate and inflation risk than they currently do.
 
 “An idea floated in a recent government consultation paper was to relax the indexation of liabilities by possibly switching indexation from RPI to the slower-moving CPI for schemes in difficulty. Though this is very much only an idea at this stage, and is far from being a policy proposal, if enacted it would represent a major departure from current legislation. Pension funds executives should be wary of placing too much hope on such a magic solution, however. Reliance on factors outside the control of most executives is not how pension schemes should be risk-managed - as evidenced by the poor investment strategies that have been enacted by those hoping that real gilt yields rise. Sensible decisions can still be taken in the current framework to mitigate the pensions problem, such as making more use of alternative income asset sources. In particular, private market real assets can offer attractive cash flow streams and diversified risk exposures for long term investors. Pension funds should take advantage of their ability to hold illiquid assets that many other investors cannot, given that most other institutional investors face either a stricter regulatory environment or shorter time horizon for asset allocation.”