Thought Leadership

Hands across the sea: How US corporate bonds could come to the aid of UK pension schemes

22/07/2016

Alistair Jones

Alistair Jones

UK Strategic Solutions

Andrew Chorlton

Andrew Chorlton

Head of US Multi-Sector Fixed Income

The options open to pension schemes trying to close funding deficits are pretty few right now. With interest rates at record lows, economic growth anaemic and markets high, the forecast returns on many assets are meagre. If there is a silver lining it may be that gilt yields are also low.

As UK pension scheme liabilities are linked to gilt yields, this means that these liabilities may not be expected to grow as fast as they have historically. Moreover, owning assets that yield more than gilts could be a helpful way to gradually offset liabilities and thereby close deficits over time. All the more appealing if those assets can also help diversify risks in the portfolio.

Currently corporate bonds would qualify on both grounds – but only in some regions of the world. The US and UK are two areas where corporate bonds currently offer attractive long-term returns. Other regions, such as Europe and Japan, look less appealing. Economies in these areas still have more to do in terms of reviving economic growth, dispelling deflationary fears and injecting more monetary stimulus.

As a result, corporate bond yields here are relatively low. This divergence in regional economic performances and bond yields around the world means
that making blanket allocations to passive funds linked to global corporate bond indices is unlikely to bear fruit over the long term. Such indices typically have an allocation of around 40% to Europe and Japan, two areas which bond investors may wish to shy away from. Now may be the time to take a more tailored approach to regional corporate bond investment.