Severe defined benefit pension funding shortfalls have been made worse by the significant post-Brexit fall in yields, and there are renewed concerns over whether pension trustees are using the full range of weapons in their arsenal to plug the gaps.
The chart below shows that a stunning 38 per cent of global government debt now yields less than zero. It also shows that if there are high-yielding bonds to be found anywhere, they are mostly in the US.
Source: JP Morgan Asset Management
This rising tide of negative yielding eurozone government bonds means pension scheme trustees are having to rethink some fundamental questions.
For instance, in this new world of negative yields, does it still make sense for pension schemes to mechanistically define their liabilities by reference to gilts, and should that measurement choice continue to dictate investment decisions?
The prevalence of negative yields has resulted in trustees having to make a decision: should they rerisk in the hope of higher rates or derisk at even lower levels?
The message from the Bank of England and from the European Central Bank is that interest rates are set to be lower for longer, so simply rerisking by shortening duration and hoping for a rise in interest rates may not be the best idea. A better idea is for schemes to consider ways in which to boost asset returns and generate cash flow.
Broadening the asset classes considered is one way in which trustees can look to increase returns and cash flows. This can include considering the wider credit spectrum, and holding higher allocations to alternatives with built-in leverage and steady cash flows.
Increasing allocations to assets that pay out a hefty illiquidity premium in return for tying up investments can add value in a world of low returns. Cost-efficient use of systematic beta exposure can add diversification and help meet return objectives.
There’s no silver bullet for which combination of strategies will be best, and the right mix will depend on a number of factors, such as each scheme’s return objectives, existing portfolio allocations, constraints and funded status.
Certainly they won’t all work at the same time, but incorporating some of them increases the probability of schemes achieving their targets in a world of low asset returns.
Alex Christie is vice-president in the pensions solutions and advisory group of JP Morgan Asset Management
