The ongoing policy of quantitative easing (QE) contributed to a £12bn rise in the pension deficits of FTSE 350 companies in 2016, leading to concerns cash that would otherwise go to payout dividends will instead go into the blackhole.
Pension deficits in the FTSE 350 now account for around 70 per cent of profits, compared with 25 per cent of profits in 2011.
According to Nick Griggs, a partner at consultancy firm Barnett Waddington, the deficit has risen drastically as a proportion of UK plc profits in the last five years, and is now even higher than it was in the immediate aftermath of the financial crisis.
If profits at FTSE350 were to remain stable, it would take just a 0.7 per cent fall in bond yields for the pension deficit to exceed FTSE350 profits by 2019.
Bond yields impact on the level of pension deficits because the bulk of the capital in the pension funds is invested in highly liquid, income bearing securities such as government bonds.
The yields available from those assets has been pushed down by the central bank policy of quantitative easing.
Quantitative easing involves purchasing bonds, particularly government bonds, in order to push the yields downwards.
The aim of the policy is to push investors out of such safe haven assets as government bonds, and into equities and other asset classes more capable of generating economic activity in a dormant economy.
But investors such as the veteran John Chatfeild Roberts, who jointly runs the Merlin range of multi-manager funds at Jupiter, has long believed that QE has generated deflation in the UK, and harmed productivity.
This in turn damages companies' ability to pay out dividends.
As company management teams end up having to put more cash into the pension funds to make up for the decline in income in the funds from bond yields, Mr Chatfeild Roberts said, companies have less cash for wage rises or investments in plant and machinery and payouts to shareholders.
Such a lack of investment has contributed, in his view, to the present weak levels of productivity growth and inflation in the UK and global economy.
Simon Gergel, manager of the £686m Merchants Investment Trust, which has increased its dividend for each of the past 35 years, said he considers the pension deficit when examining the investment case for a company.
George Godber, who runs the £302m Polar UK Value Opportunities fund, said he he would be very reluctant to invest in a company with a substantial pension deficit as he prefers the businesses he owns to have net cash and a pension deficit reduces the chances of this happening.
He said that while a rise in UK bond yields would reduce pension deficits, investors have been predicting such a rise in yields for a long time, without it happening.
But Patrick Connolly, chartered financial planner at Chase De Vere said while on the surface increasing pension fund deficits pose a threat to FTSE 350 dividends, the chief executives of those companies have a “vested interest” in ensuring dividends are paid, as it is shareholders who ultimately decide whether the chief executive retains their job.
David.Thorpe@ft.com
