Talking Head: The passage of time shows the folly of human speculation – ask any unhedged defined benefit pension fund that has been hoping for rising yields to repair its deficit.
Following the last Monetary Policy Committee meeting, the market now prices an interest rate rise at more than two years away. It also predicts a significant chance of a cut by the end of the year. As a result, the Pension Protection Fund funding gap between assets and liabilities is set to widen.
We must all suffer from one of two pains: the pain of regret or the pain of discipline.
While current levels may feel expensive, hedging cannot be relied upon to become cheaper in the coming years – even if one day the Bank of England starts raising rates
Many pension funds are underhedged due to the significant interest rate exposure from their liabilities. They perceived interest rates to be too low to hedge over the past year, or even 10 years.
Their assertion was that rates would have risen by now – or at some point in the future. Psychologically it is now almost impossible for them to bite the bullet and start hedging – this is the pain of regret.
Assumptions are dangerous things to make
The problem with this thinking is it is based on assumptions and bias. Speculating a significant amount of the total investment risk on the trajectory of interest rates should not dictate your investment strategy. This is the pain of discipline.
It is worth noting that consultancy KPMG’s liability-driven investment survey shows the use of interest rate hedging has increased over the past few years. However, more than half of UK liability exposures remain unhedged.
And while current levels may feel expensive, hedging cannot be relied on to become cheaper – even if one day the Bank of England starts raising rates.
VUCA – the acronym of our time
This has become the new normal. Making effective decisions in a world that is more volatile, uncertain, complex and ambiguous – VUCA – due to the globalisation of the world economy and acceleration of technology is a key priority for those responsible and accountable for managing pension funds.
What’s needed in our pensions industry is a counter-VUCA approach: vision, understanding, clarity and agility. A vision that pulls all stakeholders together to design a long-term strategy that repairs the pension deficit and improves member security.
Through education, a comfortable level of understanding about the available strategies can be reached to allow pension funds to implement the tools that lead to improved outcomes.
Clarity in goals, constraints, roles and responsibilities to deliver the vision.
Finally, it demands that pensions funds achieve a level of agility in decision-making.
VUCA has profoundly changed how trustees set their strategy and how their pension funds are managed. It is time to put the interest rate crystal balls down and work hard to create solutions for the uncertain age we live in.
Rob Gardner is co-CEO of Redington
