“In September the PPF 7800 Index funding level bounced from 87.6% to 90.6%, providing UK pension schemes a gift even more welcome than a cough sweet at a speaking event. Pension schemes have the Bank of England to thank for their turn of fortune; at its Monetary Policy Committee meeting earlier in the month, the Bank delivered a surprisingly hawkish message, articulating a more positive economic outlook and a clear indication that there will be a rate hike in coming months, absent any shocks. This spurred a repricing in the UK government bond market; 20-year real and nominal yields both rose by over 20bps, pushing pension scheme liability values lower and funding levels higher.
“Despite the timely boost from interest rates, over the course of the year, it is in fact growth assets that have been the greatest driver of returns for pension schemes (in the way the PPF calculates the aggregate position, at least). Equities have trended higher, with very low volatility, as an improving global economic outlook has been reflected in market pricing. But despite world aggregate equities achieving 14% local currency returns since the start of 2017, it’s notable how little the aggregate situation has improved: the PPF aggregate index is only up a few percent. What would have happened if equity returns had been less strong – or are less strong in future?
“Indeed, at the risk of being accused of finding bad news even in the good news; pension funds should be concerned that their funding levels are so susceptible to movements in market interest rates, even when it works in their favour. Many with low liability hedge ratios are experiencing more funding level volatility than they need to. The history of the PPF index suggests it is not unusual for liabilities to be more volatile than assets – in fact, it is the norm. Over the last 10 years, the average 12-month volatility of the assets in the index was around half that of the reported liabilities. Moreover - over the 10-year period, rolling 12-month volatility of liabilities always exceeded that of assets in each and every year. For the many trustees and sponsors seeking to lower volatility and close a funding deficit, this demonstrates the importance of managing both sides of the funding ratio equation – focusing only on asset portfolios rather than managing the position relative to liabilities has been a risky strategy. We advocate removing the majority of liability risk while still positioning for rates to continue to rise relative to current levels, and sourcing well-diversified income from private market assets.”
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