UK pension scheme funding has never been in a more perilous state. The latest PPF 7800 index reveals the pension scheme aggregate funding ratio fell significantly in June to 78.0%, close to its lowest ever level, following the result of the UK’s referendum and the ensuing perfect storm of heightened volatility and collapsing bond yields. Our long held view is that most pension funds are exposed to too much interest rate risk and should be increasing their liability hedge ratios. We believe that recent events make this even more critical. In the post-Brexit environment, we believe two key aspects warrant a de-risking of UK pension fund portfolios:
Firstly, a significant slowdown in UK growth and material likelihood of a recession next year could threaten the financial outlook of pension scheme sponsors. We have halved our UK real growth forecasts to 1% p.a. for the next five years. If scheme sponsors are less able to increase future scheme contributions due to financial strain, pension scheme asset risk should be reduced. We believe Trustees should consider how defensible their current portfolios are in the current climate, particularly if the recent scrutiny around the future of high profile schemes bring increased regulatory focus.
Secondly, the path of future UK interest rates is now likely to be even lower for even longer. Market pricing places the next interest rate rise from current levels toward the end of the decade. Delaying a decision to hedge liability risk is less rewarding — because we do not expect rates to rise in the current uncertain environment — and more risky — as Japan and Europe have shown there could be much further yet to fall.
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