Autumn Budget 2017: The pensions industry has had its wish granted with a Budget light on savings policy, but a worsening economic horizon may still mean heads are being scratched on pension scheme investment boards.
But while the pensions industry has had its legislative wish granted, a worsening economic horizon may still mean heads are being scratched on pension scheme investment boards.
The Office for Budget Responsibility cut its forecasts for productivity growth, now averaging 1.4 per cent over the next five years. It is reportedly the first time in modern history that the GDP forecasts have been below 2 per cent in every year of the forecast horizon.
Companies that are struggling are just limping along, still not in a position where they can attract investment
Hugh Nolan, Spence & Partners
It also noted surprisingly strong employment growth and less borrowing than expected, leaving the UK in a “better fiscal position now, but [with] weaker prospects looking forward”.
Against this background, the chancellor was forced to put any aspirations to return the UK to surplus on hold and continue borrowing, albeit at a falling level, relying on weak productivity to reduce the nation’s debt-to-GDP ratio over the next five years.
Portfolios will look overseas
The productivity figures and the wider economic backdrop have significant implications for UK pension schemes and their investment strategies.
Some experts questioned the logic behind return-seeking investment in domestic markets, given the downgrade.
“We would certainly be looking for our clients at the mix of UK and overseas return-seeking assets and we would be questioning why there would be a high weighting to the UK these days,” said Will Wolfenden, a principal at Punter Southall Investment Consulting.
Where currency risks may have pushed pension schemes away from investment in overseas markets in the past, Wolfenden said these could now be hedged out “very easily”.
Schemes must not overreact
Of course, forecasts can be wrong. “We look at forecasts, we try and make sensible decisions about what’s happening, but in the end it’s a certain amount of crystal ball-gazing, and the forecasts could be overly pessimistic or overly optimistic,” said Andrew Wauchope, senior investment director at Psigma Investment Management.
He said that both asset owners and asset managers should be careful not to overreact to the latest news.
But Wauchope added that even if forecasters around the world are wrong, the UK’s position relative to other markets is unlikely to change, suggesting a case for investment overseas.
“We have quite a focus on emerging markets because on a pari passu basis they would look more attractive,” he said.
The impact on scheme funding
A worsening economic outlook for the UK could also put pressure on those sponsors of UK defined benefit schemes who are saddled with deficits.
Paul Farrell, head of UK institutional at JPMorgan Asset Management, said: “The 1.5 per cent real GDP growth predicted by the OBR for 2017 is in line with our estimate that developed market real GDP will average just 1.5 per cent annualised over the next 10 to 15 years, meaning UK pensions will continue to struggle to generate sufficient returns to meet their obligations and repair funded status.”
He said that with few further growth downgrades expected, the funding positions of the UK’s schemes were not likely to deteriorate significantly. But equally, slow growth and slow rises in interest rates would mean schemes “grind, rather than glide” towards their goals.
“All else being equal, this will limit the pace of derisking as pension funds need to maintain exposure to risky assets in order to generate return to rebuild funding levels. This is increasingly uncomfortable as plans continue to mature,” he said, stressing the importance of diversification.
Sponsor contributions still constrained
These problems are tied to and exacerbated by uncertainty around Brexit, argued Hugh Nolan, president of the Society of Pension Professionals and director at consultancy Spence & Partners.
He said the UK’s regulatory environment, and its emphasis on investment in gilts, would continue to limit pension schemes from investing in the real economy for growth, and would see companies struggle to pay off their pension debts.
“Companies that are struggling are just limping along, still not in a position where they can attract investment,” he said, adding that fiscal stimulus would be welcomed by the pensions world.
