UK schemes advised to review long-term strategies amid bond market mayhem
Investment consultants are advising UK defined benefit pension schemes to conduct wider investment strategy and governance reviews that go beyond their liability-driven investments as the Bank of England expands its emergency bond market support ahead of the end of its gilt-buying programme on Friday.
The advice follows sharp yield rises in response to the UK government’s planned tax cuts and pressure on LDI managers to reduce the level of leverage used in their funds.
Pension funds have been encouraged to review wider scheme objectives, journey plans and governance to ensure they are fit for the 'new' market environment.
Speaking during a recent LCP webinar on gilt market volatility, Steve Hodder, partner at LCP, said schemes need to make key strategic decisions on their LDI portfolios and discuss whether they want to prioritise good long-term investment returns or liability hedging.
“Particularly credit assets are now a lot cheaper, and it may be a really good time to consider opportunities there.”
Considering pension funds have seen their funding positions improve significantly as a result of rising gilt yields, many schemes are likely to be able to keep their risk management tools in place, with less leverage, and accept lower growth investments, Hodder said.
Others will either have to accept more volatility in their funding positions or lower investment returns that may push them to ask for more contributions from their sponsoring businesses, he said.
Schemes that aim to keep their liability-hedging positions in place should sell some growth assets, if needed, to rebalance their portfolios. However, Hodder warned that some funds could come under pressure if many schemes are looking to sell their growth assets at the same time.
He also urged pension funds to review their hedging levels and ensure they are keeping some liquid assets to meet ongoing benefit payments.
But some funds may be looking to take advantage of opportunities that have emerged from the bond market turmoil.
“Particularly credit assets are now a lot cheaper, and it may be a really good time to consider opportunities there,” he added.
Trustees test liquidity plans
As the future stability of the gilt market and LDI funds remains uncertain, governance arrangements are also under scrutiny.
Anne Sander, client director of pension trustee and governance services at ZEDRA, advises trustees to “properly stress test the effectiveness of their liquidity plans and assess how they may need to rebalance their portfolios after a run on their liquidity”.
Sander says that in already unsettled markets, trustees should keep an eye on political developments that may lead to policy changes.
“Trustees should think about what they can do to monitor for potential politically driven policy changes and how they might put contingency plans in place,” she adds.
Insurers open for business
While many schemes are likely to review their investment strategies and governance arrangements in light of recent events, some are planning to sign pension risk transfer deals early.
As funding positions have improved, LCP expects schemes’ appetite for full buy-ins to increase.
“I feel that schemes will be more cautious about trades which are essentially swapping liquidity for longevity protection.”
Ken Hardman, consulting actuary and partner at LCP, said during the webinar that recent bond market moves, combined with higher interest rates, attractive pricing and a mortality slow-down, are likely to fuel full buy-in transactions.
“We are still seeing insurance companies being very much open for business. We have not seen them expressing material concerns and we have not seen them limiting their appetite for new business,” he said.
However, partial buy-ins may become more difficult in the current market environment as they could put more pressure on schemes’ collateral requirements.
“I feel that schemes will be more cautious about trades which are essentially swapping liquidity for longevity protection, and I’ve seen several clients looking to at least retest their future collateral requirements and the pricing metrics that they need for a partial buy-in transaction,” he said.
