Trustees may need to evaluate fund performance and objectives in light of the major movements in financial markets after last week’s ‘mini budget’.
Ross Trustees trustee director Pavan Bhardwaj says there have been significant movements in gilt and currency markets in response to the large increase in government borrowing.
This has including a sell-off of UK government bonds, which has pushed up gilt yields, while sterling has plummeted in value against the US dollar, and also edged downwards against the euro.
Bhardwaj says these movements show that the market now perceives the UK to be a more risky place to invest and demands greater ‘risk premia’ to do so. He adds that the announcements in the budget are inflationary and create an inherent tension with the Bank of England, which has been increasing rates to try and bring inflation under control. As a result there has been considerable speculation that the BoE will be forced into an emergency rate hike to stabilise the value of sterling.
These all have consequences for the funding of pension schemes. Bhardwaj says these moves have accelerated a shift higher in bond yields which was already occurring — due to the tightening of global central banks in order to combat inflation.
“Pension schemes are generally hedged up to the value of the transfer price of assets (rather than full liabilities) and therefore have seen rapid progress towards long term objectives. Higher bond yields since Friday will have accelerated this trend though some of the progress could potentially be undermined if growth assets react badly over coming days. Illiquids will see a lagged effect in performance.”
He adds: “ Schemes have already been required to recapitalise liability driven investment (LDI) portfolios, which entails selling out of growth assets into LDI, due to the higher yields. Liquidity is therefore the key concern going forward – schemes with high allocations to illiquids could potentially be required to take a haircut on these assets or, in extremis, reduce the target level of hedging.”
In order to address the current market challenges Ross Trustees suggests that trustees of all pension funds should consider the following:
- Asset allocations will likely have moved away from strategic targets and trustees should consider whether some rebalancing is warranted to bring growth/matching splits back towards target. This will involve selling growth assets and increasing matching assets
- Re-assess progress towards long term objectives and consider whether any de-risking is warranted
- Assess liquidity position and plan for adverse outcomes in which bond yields continue to move significantly higher and LDI portfolios need to be recapitalised to a much greater extent
- Any schemes which have a large proportion of illiquid assets could run into liquidity problems – so please flag if you have concerns
- A lesser priority is to consider FX hedging or transferring accumulated foreign currency into sterling.
- Consider putting any transition of assets e.g. appointment of new managers/fiduciary managers on hold
- Keep scheme sponsors updated on current actions