June was a washout for most in the UK, but pension schemes weathered most of the storms to finish with improved funding levels over the month. The PPF 7800 Index ended the month at 97.0%, up 1.0% from May’s low, primarily due to equity markets recovering to close to their April peaks. Amid wider global growth uncertainty, risk assets were supported by comments from both the US Federal Reserve and the ECB, indicating a willingness to cut rates and reintroduce monetary stimulus if necessary.
However, this served to push government bond yields lower, so liability values increased over the month. 10-year gilt yields ended the month at 0.92% down 4 basis points from their previous low, and with 30-year yields virtually flat at 1.53%, the prospect for rising yields to help schemes out in the near term appears limited. Indeed as yields and credit spreads remain low and becoming increasingly volatile, many trustees are considering moving to shorter duration funds, or a more flexible or absolute return approach to their growth fixed income portfolios.
In the UK, recent rhetoric from Bank of England Governor Mark Carney about the risks of Brexit and trade conflicts combined with the weakest retail sales data since the financial crisis have fuelled speculation that a rate cut is on the cards within the next 12 months. We see these escalating trade tensions and the uncertain knock-on effects onto global supply chains having a major impact on market returns in the near term. In our view, this rising geopolitical confrontation is a greater risk to global expansion than traditional late-cycle macro concerns. The increasing heat of trade and strategic tensions between the U.S. and China in particular risks boiling over but if the situation simmers down over the remainder of the year we could see continued positive growth asset returns.
With both upside and downside risks on the horizon, schemes should ensure they are aware of these and able to capture or protect against the impact: dynamic, flexible investment strategies underpinned by high levels of liability hedging would seem appropriate in the current climate. Continue carrying sunglasses and an umbrella in your bag.
Closer to home and the land of UK pensions, June also saw the release of Mercer’s 2019 European Asset Allocation Survey which showed that 73.0% of UK Pension Schemes are now cash flow negative. Perhaps more interesting is that schemes seem to still be reliant on selling assets to meet these benefit payments, meaning they might be reducing growth assets at the wrong time and further compounding their funding woes in the future. As funding levels improve and schemes approach self-sufficiency, we advocate strategies which combine LDI, investment grade credit and income generating private market assets, complemented as required by holdings in shorter-duration growth assets to close any remaining funding gap.
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