Six ways to rethink your derisking plan in a volatile world

Recently, quite the opposite has been true: oil prices fell by almost 50 per cent in 2014, inflation is falling and, particularly in Europe, low inflation is adding to growing fear of deflation taking hold.

Germany and France barely had any inflation in December, while Portugal, Ireland, Italy, Greece and Spain saw negative inflation. As a result, interest rates continue to fall.

According to Bank of America Merrill Lynch, more than 1.4bn people are experiencing negative real interest rates around the world. And there is now $7.3tn (£4.9tn) of negatively yielding debt in Europe, Japan and Switzerland.  

These market movements have had serious consequences for pension funds’ funding levels.

For example, during 2014 the PPF 7800 Index saw assets rise by 9 per cent to £1.24tn¹ but liabilities rose 29 per cent to £1.5tn¹ – with the funding deficit increasing significantly to £266bn from £28bn.

Prepare to be wrong

The problem is no one expected this, yet what happened in 2014 was not a 2008-style 'black swan' event.

The fall in 30-year gilt yields was in the realms of possible outcomes that many pension funds had seen in their risk models as part of their funding and investment strategy reviews. 

The world remains volatile and uncertain. Here are six ways to rethink your pension fund investment and derisking strategy:

• Zoom out and attain distance. Ask yourself: 'Is our recovery plan still achievable?' and 'Can we still achieve this using a level of risk that our covenant can afford to take?'
• Reality-check your assumptions. In an increasingly low-return world, ask yourself: 'Does our investment portfolio have a realistic expected return and an affordable level of risk to reach full funding?'
• The pain of discipline or the pain of regret. Relying on market expectations to come through is not a good approach for investing and derisking your pension fund. A disciplined approach avoids being caught out by the unexpected.
• The magic is in the mix. When designing your investment strategy for 2015, avoid being dependent on any one investment outcome. Design it to be robust in rising and falling interest rate and inflation environments. Then find the right mix of assets to deliver the right outcome for each environment.
• Prepare to be wrong. When designing your investment and derisking strategy, it is important to prepare to be wrong. Unexpected outcomes can do the most damage.
• A shift in investing mindset. Plan for the best but prepare for the worst. This means not focusing on calling markets but, instead, focus on what is needed to reach full funding.

Rob Gardner is co-CEO at consultancy Redington

¹The original comment piece incorrectly put the PPF 7800 Index assets at £1.24bn and liabilities at £1.5bn, but both figures should have read trillions. The article has been updated.