Market volatility is here to stay, experts have said, urging defined benefit trustees to assess their risk management frameworks and eliminate unintended exposures as the year kicks off.
Chinese equity market volatility sent global markets spinning on Monday, continuing a theme that dominated the latter part of 2015.
A global market rout on day one of trading precipitated the biggest market fall in the FTSE All World Index since Black Monday on August 24.
I don’t see any reason to believe volatility is going to reduce. Clearly that will seep through into funding levels
Le Roy van Zyl, Mercer
The end of 2015 brought a glimmer of hope for FTSE 350 scheme sponsors as accounting deficits fell to £64bn at the end of December 2015, down from £78bn a month earlier, despite falls in equity markets, according to consultancy Mercer’s latest pension risk survey.
But Le Roy van Zyl, principal in consultancy Mercer’s financial strategy group, said there is significant scope for “really bad news” during the year ahead.
Improvements in corporate bond yields may have helped funding levels on an IAS19 accounting basis, but the picture for technical provisions funding, the key basis for setting contribution rates, is “still not looking healthy at all”, according to van Zyl.
“The uncertainty out there is potentially higher than it has been for some time,” he said. “I don’t see any reason to believe volatility is going to reduce. Clearly that will seep through into funding levels.”
Creating or enhancing risk management plans, in line with the latest guidance from the Pensions Regulator, must be a priority for schemes in the current market environment, said van Zyl.
Many schemes will need to tackle risk from several fronts and implement a number of different steps to reduce stress, he added.
US caution
The focus this week may have been on China but Chris Helyar, partner and head of investment strategy at consultancy LCP, said the US will be a key market for trustees to watch this year.
“The US has been growing reasonably robustly over 2015, but there are some signs [of] some weakness round the corner looking at manufacturing data coming out,” he said.
The Federal Reserve was a first mover in its decision to push through a 0.25 per cent interest rate rise last month but Helyar said schemes should not get over-excited, with gradual rises already priced into the market.
“It’s only to the extent that rates rise faster than that schemes will benefit from higher yields,” he said.
“Even if US rates do rise more quickly than is expected it’s far from clear whether the UK will actually respond to that as well.”
Trustees should carefully review their current levels of interest rate and inflation hedging, Helyar said, and assess the case for increasing protections if they are particularly under-hedged.
Get the basics right
David Hutchins, lead portfolio manager of multi-asset solutions at Alliance Bernstein, said there was potential for US weakening but predicted buying opportunities across rebounding sectors including commodities and emerging markets.
However, he added that many schemes are running “unjustifiable” domestic biases in their equity holdings and are therefore vulnerable to “unintended exposures”.
“It’s basic asset allocation,” he said. “All this other stuff is noise – you’ve got to get the basics right.”
