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 asset pricing.
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 their hedging.
“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.
Related: The Death of LDI & CIOs: What Brexit Means for You