If you run a UK pension fund, closing that deficit just got a
whole lot harder.
Government bond yields plummeted in the day-and-a-half
of trading since the UK public voted to leave the European Union on June 23.
This morning, 10-year gilt yields fell below 1% for the first time, pushing up
defined benefit pension deficits.
Stock market losses exacerbated the effect on shortfalls,
with consultancy firm Hymans Robertson estimating that the combined deficit of
UK corporate pensions hit £900 billion ($1.2 trillion), based on aggregate
liabilities of £2.2 trillion.
It’s bad news too for those pension funds implementing
liability-driven investment (LDI) strategies.
“Schemes with lower hedge ratios will have suffered, and it
seems likely that yields will remain depressed given the uncertainties,” said
Hemal Popat, principal at Mercer.
Interest rates and gilt yields are expected to remain at
these ultra-low levels for even longer than previously thought, Popat added.
Earlier this year, some consultants were already
warning that conventional LDI strategies were not as attractive based on
David Bennett, head of investment
consulting at Redington, said LDI implementers should monitor the effect of
market movements and interest rate changes on their entire portfolio.
“If there’s a further fall in interest rates resulting in
increase in the value of your LDI strategy as a proportion of your portfolio,
then you have to think about rebalancing,” Bennett said.
However, he emphasized that Redington would be advising
clients to maintain current strategies while seeking opportunities to increase
“We briefly debated whether there is a point at which rates
would get too low and you shouldn’t hedge,” Bennett added. “Would you hedge if
rates were at zero? We think that’s a long way off.”
Martijn Vos, managing director at Netherlands-based
consultant Ortec Finance, said many European pensions were “already adjusting
for a low rate, low growth environment” while also grapping with a “low risk budget.”
Dutch pensions in particular struggled regarding funding positions even before last week. “The
immediate reaction was limited, but it’s very clear [Brexit] will make rates
stay low or get even lower and make it even more difficult than it already
was,” Vos said.
Death of LDI & CIOs:
What Brexit Means for You