Equity fund managers are sizing up the extent to which plunging bond yields will affect companies with hefty pension liabilities as corporates reckon with another step down in interest rates.
The pension obligations of UK plc have returned to the spotlight this summer as bond yields fall to new lows in reaction to a cut in interest rates by the Bank of England. The drop in yields makes it harder still for pension funds to match assets with liabilities because available income levels are lower and predicted future costs are higher.
Ratings agency Fitch said last month that companies’ growing need to make up these pension shortfalls could “create a cashflow drain” for businesses. But fund managers are more circumspect for now.
“One of the reasons turnover has been so low is there’s a lot of thinking going on. We are still in the early stages of thinking more broadly about what this move in gilt yields actually means,” said Jonathan Barber, manager of the Threadneedle UK Monthly Income fund.
Matthew Jennings, investment director at Fidelity, acknowledged the drop in gilt yields was affecting some investment decisions, and Alastair Gunn, manager of the Jupiter Distribution fund, said: “It’s quite a turn-off, but I’d also say it’s not a reason for me to panic out of anything I already own.”
While managers are pondering, one smaller stock has already suffered the consequences. Manufacturer Carclo saw its shares slump last week after warning that its pension deficit had widened to an extent that made the payment of its dividend unlikely.
“Our first take is that [the company] hit a slightly technical accounting problem, which probably makes it an exception,” said Mr Barber.
“There might be a few more, but the fact they’ve got caught out probably reduces the likelihood that many others will be.”
The Threadneedle manager said the practice of calibrating dividends by assessing distributable reserves on a balance sheet was a “nebulous” exercise, which could be resolved through actions such as revaluing assets to increase the value of profits.
“I think I would be OK with that,” he said.
Nonetheless, with research from Goldman Sachs showing firms with sizeable pension deficits have underperformed the wider market since the EU referendum vote on June 23, the Carclo episode has underlined the need for managers to scrutinise corporate accounting methods more closely, according to Fidelity’s Mr Jennings.
“The market periodically goes through phases of being more focused on pension deficits. Different companies make quite different assumptions in their accounting. This is one area where you really do need a very detailed approach to analysing accounts,” he said.
“This is also an area where trustees and companies have to work very closely together in order to be successful.”
Research from consultants Lane Clark & Peacock has suggested some companies may be pulling in the other direction. It found FTSE 100 firms paid £71bn in dividends last year compared with just £13.3bn in pension contributions.
When it comes to meeting deficits, Mr Barber said companies would be hopeful of simply extending a typical 10-year payment horizon to 12-14 years to keep annual costs at the same level, while Mr Gunn suggested policymakers had adopted an open mind on the issue.
“I think regulators and governments are keen to allow longer resolution periods. They recognise that the economy needs to grow in a sustainable way. That isn’t going to be consumer-led, the consumer is already heavily indebted. They need businesses to be able to invest,” the Jupiter manager said.
