The choppy seas of recent months continued in March, causing UK pension scheme funding levels to fall on average despite growth assets delivering positive returns. Liabilities rose over the month as UK long dated gilt yields fell in response to continued uncertainty over Brexit. While equities and other growth assets also rose, this was not enough to counter the headwinds of liability valuation increases meaning the PPF 7800 Index fell by 2.1% to 97.4%.
In general, pension schemes appear to have withstood most of the surprise equity market falls in the latter months of 2018 and equity markets have retraced most of those losses over the first quarter. This is mirrored in other asset classes such as global credit, high yield and emerging market debt. With yields falling 60 basis points over the last six months, increasing liability values by over 10%, those schemes with LDI strategies in place will have come through the period largely unscathed and can sail on to sell-sufficiency. They can be confident navigating through deeper waters in search of more interesting assets and opportunities to depower the sails and de-risk as they near the treasure island of self-sufficiency.
Those without LDI will have seen deficits widen, meaning they require higher return strategies, and will have to steer through more challenging seas taking more risk in the process. LDI enables schemes to keep their growth allocation in place, dynamically hedging liabilities when the need arises, and reducing the risk of attack by the “deficit pirates”.
So are there calmer waters ahead for UK pension schemes? The outlook for global growth remains reasonable, notwithstanding the ongoing local concerns around the UK’s exit from the EU, and markets continue to recover from the falls in the fourth quarter of 2018. While the Fed, ECB and Bank of England have all signalled their intentions not to raise base rates for 2019, will it therefore be plain sailing for UK trustees? We think not, unless their schemes have reasonable levels of interest rate and inflation protection, combined with sufficient diversification and critically dynamism in their growth portfolio enabling their ship to change tack to avoid stormy patches, or batten down the hatches if a sudden squall hits.
Looking further afield (or should that be asea?) for tailwinds, there is continued evidence that pension schemes are allocating more towards alternative investments. Real assets in particular are attracting attention and we see definite merit in exploiting opportunities which are only available to long-term investors such as pension funds: infrastructure debt and equity, real estate debt and equity as well as structured credit, securitised assets and specialty financing. Even hedge funds are making a comeback as schemes seek additional returns and increased diversification.
Can trustees take the opportunity to be masters of the high seas, embracing new techniques and asset classes, or are they destined for the Bermuda Triangle of no return, continuing to rely on outdated traditional methods to get them out of trouble?
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