With the Cricket World Cup having started and already producing some surprise results, UK pension scheme trustees may have been reminded of the risks of being complacent when things are going well. Having ended April on a high note, the PPF 7800 index dropped back over May, conceding 3.6% in funding level terms to finish at 96.0%. Entering May at all-time highs, cheap wickets were lost as equity markets reacted negatively to expectations of increased US tariffs on China and Mexico, falling 3-5% over the month. Bonds rallied so total scheme assets rose slightly but this was not enough to prevent funding levels from dropping. UK 10-year and 30-year gilt yields fell around 0.25% to 0.96% and 1.52% respectively, below where they started the year. Indeed 10-year gilt yields ended the month at less than 1%, the lowest they have ever been, other than around the UK-EU referendum three years ago. Once again, schemes with higher levels of hedging would have been able to bat out the month relatively unscathed, their matching assets keeping up with the 4.6% rise in liability values.
These market moves serve as a reminder that unusually low levels of market volatility may not accurately reflect the risks in this late-cycle period. Continuing to chase runs with a high-risk approach could land schemes in trouble, losing ground at a vital time. We continue to see schemes approaching the endgame who haven’t thought about their strategy for the final few overs of the chase. A more gung-ho approach may be ok if you have a strong sponsor to back you; for most schemes, keeping a cool head may be more suitable. As in cricket, assessing the conditions is key – you never know when volatility will hit and it’s going to get spicy.
With funding levels now at their lowest levels since October last year, it is clear that funding level volatility and therefore risk management remains a key concern for Trustees. LDI strategies are central to the chances of schemes’ success. With May’s manufacturing data showing the worst decline in orders for two and a half years, and IHS Markit stating that the UK economy is now at its weakest since 2012, it seems likely that schemes are going to have to get used to rates being even lower for even longer. May also served as a timely reminder for schemes to have de-risking plans in place which allow them to lock in funding level gains (such as those in April) quickly and efficiently. Doing so should help them to avoid being caught out when volatility spikes. Above all, in order to achieve their funding goals, trustees should ensure they have the right support team in place: could a fiduciary management approach be a better way of ensuring a suitable asset line-up?
Looking further ahead, with new ESG regulations coming in to force from 1st October, trustees will be considering how to incorporate their views into their portfolios. Whilst it is relatively easy to incorporate ESG into equity allocations and trustees can invest in renewable energy on the alternatives side, it is less obvious how this can be done within fixed income portfolios. However, in May the Dutch State Treasury Agency issued its inaugural Green Bond, to fund renewable energy, energy efficiency, clean transportation and climate change adaptation. Perhaps if the DMO were to follow, schemes could move to an ESG aware LDI portfolio whilst still hedging their interest rate risk.
|
