Defined benefit schemes should widen their core investment universe beyond gilts or face ever-growing deficits in the wake of the base rate cut to a record low 0.25 per cent, JP Morgan Asset Management head of pensions advisory Sorca Kelly-Scholte has said.
Trustees should consider increasing exposure to other forms of credit, as well less liquid asset classes such as infrastructure and property, and valuing their liabilities accordingly, she said.
This would decrease the overall liabilities of DB schemes, but Xafinity’s head of proposition development Paul Darlow told FTAdviser it would not necessarily reduce DB transfer values, which are currently at record highs.
Most experts agreed the rate cut, along with the £60bn quantitative easing programme, would put further downward pressure on gilt yields - already at record lows - and that this would spell bad news for gilt yield-dependent defined benefit schemes.
Ms Kelly Scholte described it as “the thousandth cut to beleaguered UK pension schemes”.
She said hedging against further gilt yield falls was no longer sufficient, because with yields as low it “effectively equates losing money with security”.
“So we ask a different question: does it continue to make sense to mark pension liabilities to gilts, and to allow that measurement choice to dictate your investment choices?” she said.
She went on: “Against this backdrop, broadening the opportunity set to include a wider array of assets that can help secure cashflows, to allow more cost-effective management of the liability cashflows, is a rational strategy.”
Following the rate cut, pensions consultant Hymans Robertson reported further falls in gilt yields had added an additional £70m to the UK’s aggregate DB deficit, putting the total at £2.4tr and the deficit at £945bn.
That pushed up the value of DB transfer valuations, which are calculated according to how much it will cost a scheme to meet its obligation to a member in today’s money. When yields are low it takes more money to meet obligations, which means the transfer value is higher.
On the morning before the rate cut, Xafinity reported that DB transfer values had hit a record high in July. At the end of the month a 64-year-old with a guaranteed annual pension of £10,000 could expect to receive a lump sum of £125,000. That was £22,000 more than it would have been in January 2016.
Xafinity’s Paul Darlow said JPMAM’s suggestion was “sensible”, given gilt yields were artificially depressed and therefore did not accurately reflect the cost of meeting liabilities.
But he added because people transferring out of DB schemes were usually on the cusp of retirement, and were therefore mostly invested in low risk assets - i.e gilts - while overall the scheme’s liabilities might be reduced by changing the valuation method, individual transfer valuations could continue to be calculated using gilts.
james.fernyhough@ft.com
