From the blog: Gilts have been a perennial favourite for UK pension schemes, not simply for their liability-matching properties, but also because of the returns they have delivered for schemes in years when markets have wobbled.
However, what was once a classic trade in times of trouble for risk markets now looks less compelling.
The unfortunate truth is that after years of declining yields (and corresponding gains for investors) the market environment has shifted significantly since the last downturn.
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However, what was once a classic trade in times of trouble for risk markets now looks less compelling. The unfortunate truth is that after years of declining yields (and corresponding gains for investors) the market environment has shifted significantly since the last downturn.
Government bonds no longer offer the same defensive kicker to investors that could have historically been relied upon
With yields as low as they are, in the event of a downturn gilts cannot deliver the same gains as they have in the past, meaning schemes need to look further afield.
Gilts poorly positioned for downturn
The UK’s debt situation looks more and more like Japan’s some years ago. With low yields, Japanese government bonds struggled to return a third of the return that UK gilts delivered in the latter part of 2008.
Bond yields in Japan were a little higher then than the UK’s are now (although only marginally) and so government bonds no longer offer the same defensive kicker to investors that could have historically been relied upon.
So what is the answer for pension schemes? In short, they need to get smarter and think about more attractive alternatives that can deliver in the event of a downturn in equity markets.
With equity market valuations sitting near record highs, this is very much a live issue – multi-asset portfolios need to think about other options very carefully.
Alternatives still offer protection
So what is on offer? Very few traditional asset classes are going to help, with corporate debt also looking very expensive.
So more alternative investments need to be considered. These could include catastrophe reinsurance, hedge funds and even income-focused property – as while linked to the economic cycle, it can hold up well if equity markets wobble without a recession ensuing.
Now is also the time when it might be worth paying for more explicit protection. Using equity options to allow you to remain invested, but protected if equity markets fall, is a particularly interesting avenue to explore right now.
Barbara Saunders is managing director at River & Mercantile Solutions
