Pension funding levels worsened again in February to 79.8% from 80.5% according to the PPF 7800 index. This modest fall masked much larger intra-month fluctuations, however, as the FTSE fell to its lowest level in over 3 years before fully recovering its losses. At the same time, long-dated index-linked gilt yields fell 15 basis points before then rising 20 basis points, implying fluctuations in an average pension fund’s liabilities of up to 5% during the month. Over the month, unstable investor sentiment was fuelled by mixed economic data and Brexit concerns. Rates markets were plagued by uncertainty as market expectations deviated from the path suggested by official monetary policy.
Under-hedged investors should strongly consider the consequences of maintaining excessively low hedge ratios in an environment where rates are increasingly volatile – we think most pension funds should be hedging more now. For those who are hedging more, the appropriate mix of LDI assets needs to be carefully considered given the complex impact of regulatory changes on trade execution and derivatives management. Pension funds should also not be fooled by the relatively mundane month-on-month changes – the need to put in place strong portfolio risk management has never been more crucial.
Asset valuations can be stabilised using alternative assets, and we encourage pension funds to consider further allocations to private markets in particular. The illiquidity premia, stable cashflows and diversification benefits associated with infrastructure, private credit and real estate, for instance, can be significant. Such assets can help pension funds access the cashflows needed to cover benefit payments in a cheaper way than through traditional matching assets.
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