Thought Leadership

The major pension themes for 2015

Like death and taxes, one thing is certain in 2015: the changing policies of governments, regulators and central banks will continue to have a significant impact on pension schemes.


Like death and taxes, one thing is certain in 2015: the changing policies of governments, regulators and central banks will continue to have a significant impact on pension schemes.

Stormier waters ahead

In 2015, pension schemes face an ever-growing number of risks that could throw their investment strategies off course. Whether it is less optimism about Chinese growth expectations, possible eurozone deflation, eastern Europe, the Middle East, the falling oil price or a UK general election, there will be plenty to make investors nervous.

With a few notable exceptions, the last few years have seen a relatively benign environment for markets, with unusually low market volatility. It seems likely that markets will become more choppy in future, as political and economic developments cause swings in investor confidence. The Credit Suisse Fear Barometer, which measures the level of fear in markets by using the price of buying equity protection, has been steadily increasing over the last five years (see chart).

The Credit Suisse Fear Barometer shows investors growing increasingly nervous

The CS Fear Barometer measures investor sentiment by tracking the cost of selling an equity call option and using the proceeds to buy a put option. The higher the level of the index, the higher the ‘fear’, as investors are willing to sacrifice more of the potential upside gains on their investments to purchase protection.

Source: Bloomberg. Period shown is from 1 January 2005 to 12 January 2015.

In light of this, many pension schemes are reviewing their exposures to benchmark-relative investment strategies in favour of more outcome-oriented ways of investing. For example, in fixed income, schemes are investigating strategies with a wider remit to take active positions across currencies, interest rates, and different sectors. In equities and other growth assets, schemes are increasingly seeking ways to protect themselves against large market corrections without sacrificing too much long-term return.

Will gilt yields finally start to rise again?

In recent weeks, UK gilt yields have fallen to all-time lows, causing more pain to pension schemes, which have seen the value of their liabilities rise yet again and their funding levels sink.

Many expect central banks in the UK and US to raise interest rates next year. However, with lower growth expectations in other regions such as Europe and China, the global recovery is an unsteady one at best.

Furthermore, the market already expects short-term interest rates to rise, and this is priced into the yields available from longer-term gilts. Interest rates would need to increase faster than the market expects if schemes are to benefit from falling liability values.

Trustees will need to take all of this into consideration when determining how to manage their liability matching strategies in 2015 and beyond.

The DB implications of new pensions flexibility in DC

Last year’s radical changes to defined contribution (DC) pensions giving members new flexibility in retirement will have ramifications for defined benefit (DB) schemes too. DB members will also be able to take advantage of the reforms by transferring to a DC scheme when they retire and then cashing in their pension entitlements.

Although the changes take effect from this April, it is still unclear how many DB members will take advantage of the opportunities they open up. However, trustees are expecting (and indeed many are already experiencing) a big increase in the number of enquiries from members asking about transfers.

If it transpires that large numbers do want to move out of DB, trustees should consider reviewing their investment strategies. A big outflow of assets could radically change a scheme’s liabilities both now and in the future, while the liquidity requirements will almost certainly change too.

Increasing popularity of flight paths

A survey* conducted in 2014 found that 50% of DB schemes now have a flight path strategy in place, and that the proportion is growing every year. This trend is in line with both our experience with trustees and the direction in which regulation is moving.

The Pensions Regulator released its latest funding guidance statement in July 2014. A recurring theme of the statement is the importance of an integrated funding and investment strategy. One-way schemes are achieving this is to use a flight path strategy which seeks to reduce risk as their funding level improves. Some include pre-agreed triggers to de-risk quickly when opportunities arise.

Until a few years ago, such strategies were only really feasible for schemes with the time and the budget to spend on investment strategy. More recently, the market has adapted to provide simpler and lower-cost flight path solutions which can be accessed by pension schemes of
virtually any size.

*GfK Financial, The Pensions Regulator, Occupational pension scheme governance survey report, May 2014.


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