UK pension scheme funding levels fell slightly over the month, with the PPF 7800 index finishing at 96.1%, down from 96.3% at the end of July. For UK pension schemes a slight increase in asset values was more than offset by a small rise in liability values.
Whilst the S&P 500 ended the month up, setting a new record for the longest bull market in US history, the rest of the world struggled with trade tensions, Italian bond market volatility and negative price action in emerging markets currencies, particularly Turkey causing risk assets to sell off. Of particular interest is that despite relative optimism for the global economy year to date returns are lower for almost all asset classes than they were at the end of May, showing how quickly returns can be eroded in volatile markets.
10 years on from the beginning of the financial crisis, August was a reminder of the need to pay heed to the lessons learned then – notably the need to build a diversified strategy that can capture upside whilst also offering protection in market drawdowns as this makes it easier to climb back up when volatility subsides. As such, we anticipate increasing interest in absolute return bond funds and diversified growth funds as schemes recognise the need to build resilience into their portfolios and invest in strategies which offer return as well as capital preservation in more challenged markets.
It was also a reminder that trustees should be thinking about their schemes in a more holistic manner to avoid portfolio shocks. Trustees should focus on risk management; the hedging of liabilities; the risk drivers of return; the potential for cashflow strain; plus in the current environment currency hedging (particularly pertinent given the swings we have experienced as a result of no real Brexit news). Looking at scheme investments holistically should also ensure that schemes don’t de-risk too early and have the ability to capture upside when present. We see potential upside surprises to consensus – particularly as market participants currently fear that quantitative tightening (G3 countries reducing their balancing sheet assets) will drain liquidity and put pressure on risk assets.
However, we argue that quantitative tightening is not quantitative easing in reverse. Instead, we believe that private sector growth means more liquidity exists in the market and that the market may have overestimated the impact quantitative easing had on risk assets. Yes, there is still uncertainty with regard to the wider array of potential outcomes to the upside and downside, this just serves to re-emphasise the need for investments which both generate return and keep an eye on the downside.
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