As temperatures have soared, so has the PPF 7800 index, which showed no signs of resting for the summer break, gaining 1.4% to reach 96.3% at the end of July. Global stock markets were positive for the month led by strong corporate earnings and reduced trade tensions, despite some sanctions coming into force, helping scheme funding levels to bounce higher. Whilst this is certainly an improvement on June’s closing level and since the beginning of 2017, schemes have not yet reached the heady funding heights of 96.9% experienced at the end of January – and with equity volatility expected to increase, gilt yields remaining stubbornly low and increasing Brexit and trade uncertainties causing concern, we may see these gains eroded over the remainder of the year.
Some schemes may hope that rising UK rates will improve funding positions further, but whilst the Bank of England raised rates as expected at their August meeting, we think context is important here; we are still far below previous norms and the rising of short term rates in the UK has little bearing on the long-end of the yield curve due to structural forces; demographics, pension fund demand and, more broadly, a build-up of global savings that are seeking safe, liquid assets. These rates are what really matter for UK pension schemes and whilst these remain low pension scheme liabilities will not decrease. Perhaps more interesting here was the Bank’s decision to raise rates despite relatively weak economic data and an economic outlook overshadowed by uncertainty of the outcome of Brexit negotiations. BlackRock’s Macro GPS, which aims to give a read on the growth outlook for G7 economies and China, has only modestly recovered in the UK from the impact of the Brexit vote and still remains well below the remainder of the G7.
With bond yields unlikely to bail schemes out any time soon and equities not expected to return the same as in previous years we recommend schemes think outside traditional assets in order to meet their funding needs. However, schemes shouldn’t just focus on return requirements outright – we encourage schemes to take a holistic approach to portfolio construction which combines risk, return and cashflows to meet the outcomes they desire. Looking to a combination of LDI, income generating private market assets as well as absolute return bond funds and the broader fixed income universe should serve pension schemes well in what is shaping up to be a more turbulent end to 2018.
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