Key points:
• UK DB deficits now stand at £825bn, representing a £35bn improvement in funding levels since last week’s US election results
• This swing of more than £200bn from an all-time high of £1,030bn in August this year underscores how volatile deficits can be and the importance of managing scheme risks
• The improvement in deficit positions could create a significant opportunity to reduce risk for some DB schemes
Commenting on what’s been driving the increase in bond yields, Calum Cooper, Partner at Hymans Robertson said: “Following a significant rally earlier this year, we’ve been seeing positions in fixed income assets unwind due to emerging signals from the Federal Reserve of higher economic growth and interest rate rises which have been amplified significantly by what the market has been calling the ‘Trumpflation trade’. This has seen increasing allocations to growth-focussed assets that are likely to benefit from the expected policies of the President-elect, such as spending on infrastructure, tax cuts and trade protectionist policies.”
Discussing what this means for DB schemes, he added: “If the experience of the past year, and particularly the past 6 months teaches us anything, it’s that deficits can be extremely volatile. But these huge gyrations in headline funding figures should not knock schemes off course. A long term focus needs to be maintained through short term political fog and uncertainty.
“To have that long-term focus, first you need to know what your long-term target is and have a timeframe for meeting it. Schemes need to understand their measures of success, risk and security and look at ways to improve these through evolving their strategy.
“Looking at what’s happened to funding positions through a long-term lens, what we’ve seen over the past week points to an opportunity to reduce risk. We’re seeing £200bn less returns required across around £1.5trn of assets from peak to trough. Very crudely, this means that some schemes can look to reduce their growth asset allocations by 10% or 20% for a given chance of success – which is, even when looked at through a long term lens, strategically significant.
Alternatively, schemes could look to reduce reliance on interest rates rising faster or to higher levels to clear their deficits by locking in to current rates.
“Of course, the opportunity and optimal action to reduce risk will vary scheme to scheme depending on their levels of growth, income and protection in their asset strategy, their asset coverage and covenant as well as the maturity of their liability profile. Having access to bespoke ‘on demand’ valuations and strategy analytics, and a clear de-risking road map, means you can easily assess and capture any opportunities that may emerge from the political fog. £250bn less growth asset risk, for example, could save some schemes £50bn in a distressed year and with forced asset sales from cashflow negativity – when schemes have to sell assets to pay the pensions promised, this loss would accumulate without careful cashflow planning.
“Given this risk and opportunity here, it’s really important that Schemes are clear on the level and types of risks they’re running; whether less risk can be taken given recent yield rises; and whether component risks could be better diversified.
Overall this should lead to increased resilience to adverse cashflow and balance sheet events.”
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