The steady increase in bond yields over the course of 2013 has had various macroeconomic consequences, few of which The Value Perspective would presume to comment upon. One area affected by rising bond yields that does fall squarely within our more company-specific approach to investment, however, is corporate pension fund deficits.
Pension fund deficits have in recent years proved a major concern for many businesses and in the past we’ve discussed pension related issues for companies including Taylor Wimpey, Trinity Mirror and, of course, BT, the traditional poster-company for any article on this topic – and who are we to ignore tradition? Over the year to 31 March 2013, the telecom giant has seen the size of its net pension deficit increase by some £3.5bn, largely due to what are known as discount rates.
Discount rates – which are used to give some idea, in today’s money terms, of how much a pension scheme will ultimately have to pay out to its members – are linked to bond yields. Therefore, as bond yields fell as policymakers reacted to the financial crisis, so did discount rates and this in turn led to the liabilities of company pension funds increasing significantly.
However, this does of course work both ways and, should bond yields continue their upward path from the very low levels of the recent past to what have, historically, been seen as ‘normal’ levels, then the very large and very frightening negative numbers, on which investors are prone to focus whenever they pop up on the balance sheets of BT and others, may start to shrink in size.
BT has actually paid a large amount of cash into its pension scheme in recent years, for example making a £2bn lump-sum contribution in March 2012, but the benefits of this to its deficit have kept being offset by the falling discount rate. Should that start to go the other way, it will potentially have a significant impact – not only on the size of the reported deficit but, much more importantly, on the amount of money the scheme’s trustees decide should be paid into the fund on an annual basis. The company’s most recent annual discloses that each 0.25% increase in the discount rate has the effect of reducing BT’s pension liability by £1.7bn, so the size of the pension deficit could change very quickly.
Obviously that will in turn affect how much spare cash the company has with which to invest, pay dividends, buy back shares or do other similarly attractive things for its shareholders. Furthermore, while BT may be the most high-profile example of a business adversely affected by its pension deficit, it is certainly not alone and a normalisation of bond yields could be good news for many shareholders in companies.