Commenting, Jon Hatchett, Partner and Head of Corporate Consulting, said: “When we looked at the figures on Thursday, UK pension deficits had worsened to the tune of 5% of GDP over six weeks. Uncertainty over Brexit led to falls in growth asset prices as well as further drops in already ultra-low yields which is hammering liabilities. Since then we’ve seen the combined UK deficit bounce back by £30bn over the weekend. This shows just how prone to volatility UK pension schemes are.
“Companies are being hit hard by pension deficits. While the large majority of companies are currently strong enough to support these schemes, recent high profile cases such as Tata and BHS bring the risks into the spotlight. Volatility in funding levels means surprises for sponsors about how much cash they’ll need to contribute to shore up schemes. It also puts the security of pensions promised to workers at risk.
“The reality is DB schemes are more prone to volatility than they need to be. Events of the last week are not unique from a pension funding perspective. Back in February we saw the collective UK DB deficit hit its ever highest level at just over £900bn. This was followed by another swing of more than £100bn in a 6 week period, from mid-February to the end of March.”
Discussing why schemes are prone to volatility he added: “It needn’t be this way. Too many schemes continue to take too much growth risk with too little protection. By allowing sponsor contributions to be driven too directly by volatile asset prices, schemes compound the problems they cause sponsors.
“This can be compounded for schemes which are more mature. Without a clear disinvestment plan, schemes can find themselves forced to sell assets at inopportune times. This exacerbates the underlying market volatility.”
Commenting on what pension schemes can do to ride out current volatility, Andy Green, CIO, added: “Clearly current volatility in markets will be a worry for many. Those running DB schemes need to remember that pensions are a long-term game and avoid knee jerk reactions to this. However, it would be sensible to have contingency plans in place, particularly looking at whether hedging levels are appropriate for a potentially bumpy ride ahead.
“It’s an inescapable fact that events over the next week relating to the uncertain but binary outcome on Brexit will present challenges for pension funds. Pension funds invest in sterling denominated markets and in global capital markets. They are caught between a rock and a hard place in the run up to the Referendum, affected by the increased volatility in sterling and unpredictable growth.
“There is limited action funds can take to protect themselves fully, although any fall in expectations for UK GDP growth are likely to weigh on equity markets and on interest rates – putting more pressure on funding deficits.
“After a steady slide in its value over the six months to April, sterling has followed the trends in the polls, rallying over April and most of May until falling again through the first half of June. In its latest gyration, sterling has started the week of the Referendum vote with strong gains.
“Many pension funds hedge an element of the currency risk associated with investing in non-UK markets. With consensus forecasts suggesting a 10% fall in sterling in the event of a vote to “Leave” and up to a 5% gain for a “Remain” win, pension funds are caught between the potential of having to crystallise losses on any currency hedging programmes in the event of a “Leave” win, and falling values of overseas investments, in sterling terms, in the event of a vote to “Remain”.
“Markets do not like uncertainty. The Referendum has led to a degree of “risk off” and increased volatility. Whatever the outcome of the vote, investors and markets will be able to move on with a degree of more certainty, although this is limited if the outcome is to leave, with the risk of another Scottish Independence vote.”
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