How is monetary policy uncertainty affecting fixed income?

William Nicoll: It is clear there are bits of the market that are not offering great value and where it is very difficult to get particularly interested, given the current monetary position. It is also clear that the Bank of England has taken long rates down below where you would normally expect at this stage of the economic recovery.

That should reverse at some point. These are statements of the obvious. Therefore, you can run a reasonable argument that says there are some parts of the market where people are being driven, but where yields are not as attractive as you would hope.

But, in terms of when and how that reverses and what the triggers would be, I have to say that is not the way we operate. What we do is find assets that are still attractive and perform a function in relation to the liabilities. There are still areas where you get a sensible matching for pension funds and insurance companies. The market, therefore, is one of niche ideas that work.

Tim Giles: Yields, still, are very low. Bonds generally look expensive, although there are areas of value despite that. Most schemes are on a journey to buy a portfolio of bonds, ultimately. A lot of this just comes down to affordability.

However, ultimately, some of it gets back to if you have the money, then regardless of cost now you can get the matching portfolio in place. I think one of the challenges at the moment is you still see relatively low levels of hedging against the liability risks within UK pension schemes. It is still very, very low. What does that mean?

Schemes are taking a substantial bet that bond prices will get substantially cheaper. But, while they might get cheaper, they might not go back to historic levels. Therefore, we are trying to encourage people to take away some of that liability risk. That is not necessarily because we are saying that bonds are going to stay at the same price as they are for now, but because you want to reduce that risk to give you a more stable path to your ultimate goal.

But, fighting against that, trustees still struggle a lot with some complexity surrounding better entrance to the fixed income markets and with this gap between short-term rates – which are really low and the market is already pricing in significant rises in rates – what you have to allow for is how you expect rates to rise relative to the market’s expectations.

Carl Hitchman: For many the issue is not low interest rates per se but the shortfall in assets relative to liabilities. The same argument can be applied to the credit markets. Rather than worrying about whether rates are low, perhaps the question to be addressed should be, ‘What return do we need to complete the journey plan and can we achieve these returns via investing in a credit portfolio?’

While this introduces credit risk, it is very different to the risks associated with equities. If you can identify a credit portfolio that is expected to deliver the required returns, the question is: why would you not invest in that now?

John St Hill: The really hard thing now is that as low rates unwind, clearly UK bonds do not look too attractive at 2.5 per cent yields. With the withdrawal of liquidity, then it is not unreasonable to hypothesise that you could get a sell-off in equity markets. Some investors might turn to credit, however credit spreads are not too far off where they were in 2007.

Pension funds, therefore, are in a difficult situation. They want to try to earn high yields in order to recover deficits. However, at the same time they want to minimise risk to their liabilities. Unfortunately, all the assets that one would ideally like to own to minimise risk are expensive.

Funds need to look at areas in which they have a competitive advantage in the financial marketplace. That speaks towards owning assets which other market players may find harder to own. For example, illiquid assets that have long-term stable cash flows could be attractive for pension funds.

Hitchman: This plays very much to the point I was making. In particular, assets like private debt are offering yields which, if achieved, would help many pension funds achieve the returns they need. Private debt provides a real opportunity for many pension funds that do not need the immediate liquidity inherent in many of their current investments.

One of the challenges in relying on equities is what happens when interest rates start rising. While we see sensible growth in the UK and other parts of the world, I expect rising interest rates will provide a headwind to equity market valuations.

David Felder: The market has consistently expected rates to start to increase and been consistently disappointed. That has been the story of the past two years or so. If you look at the yield curve, it has been predicting a turn in the interest rate cycle. There have been various phases where it looked like rates were starting to revert to normal levels. Then they have just fallen away again.

What it means as a trustee, very directly, is that we are stuck in a low, risk-free, interest rate environment for longer. Even if base rates do [go] back up to the levels that the futures market is now predicting, which is 1.5 per cent at the end of next year, you are still talking about a low interest rate environment.

What does that mean for pension funds? Essentially, if you can find products which offer reasonable security and a useful margin over a risk-free return, proportionately, you are vastly increasing your return by going for something that yields 2 per cent rather than 1 per cent. That 1 per cent spread, even if it looks compressed, is still very valuable.