“World stocks sank further yesterday due to mounting fears of a Chinese-led global slowdown. Here in the UK the FTSE100 has fallen around 5%. Bond markets have been affected too, with yields moving south.
“This has led to the aggregate deficit of UK private sector defined benefit (DB) pension schemes widening by c£30bn in one day.
“Monday’s market movements send a strong message to companies and pension trustees to place greater emphasis on managing the risks in pension schemes. Volatility in capital markets is a fact of life. As we’ve seen yesterday, market sentiment can turn very quickly.
“Many UK DB schemes are taking more risk than they need to – a fact that yesterday’s market movements will have brought into sharp focus. In this context, companies providing DB pensions and the trustees running them should focus on two key questions.
“First, is your allocation to equities and other growth assets appropriate? Following research last year, in our view many schemes have greater allocations to long-term growth assets than they actually need. The investment time horizons of DB schemes are shortening, and there is a need to avoid selling assets at depressed prices to make benefit payment. UK ltd DB schemes are paying out c£20bn more in benefits than is being received in contributions, yet the average DB scheme still holds around 50% in growth assets. There is an urgent need for the focus to shift from a long term investment mind set, to a more balanced approach which recognises the importance of shorter term risk management. Switching more from ‘growth’ to ‘income’ assets may well be an appropriate move for your scheme.
“Second, have you got appropriate protection in place to safeguard your scheme through the inevitable bumps in the road? While interest rate and inflation protection increased by £20bn per quarter in 2014 across UK plc, there remains some way to go to reduce financial risk. Schemes are still collectively taking a ‘many hundreds of billions’ bet on the future path of interest rates and inflation – a bet that has certainly not paid off since the turn of this century.
“Our main message to sponsors and trustees is to avoid any temptations to rush into deficit recovery mode, which usually places an emphasis on investing in long-term growth assets. This kind of long term thinking is increasingly myopic for schemes looking up at a mountain of cash payments in the near term. Specifically, this will not address the risks associated with increasingly paying out significantly more in pensions to retiring members than is being received in cash contributions.
“A different approach is required: slower deficit reduction, taking no more risk than is needed and investing in assets that can be relied upon to pay today’s and tomorrow’s pensioners. It’s important to remember that, from an investment perspective, for a lot of schemes this is no longer a long-term game – it’s all about assets backing cashflows.”
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