Recent weeks have seen 10-year gilt yields reach 1.16 per cent, their highest level in four months, in a sign inflation is creeping up in the UK economy.
2016 has been a tough year for defined benefit funds, with falling yields pushing up the value of liabilities, which in turn has sent the deficits of some poorly hedged schemes into a spiral.
August saw a record-low 10-year nominal gilt yield of 0.5 per cent, and September provided little respite for pension fund investors.
Where you have schemes that have fixed pension increases it’s certainly an opportunity for those schemes to increase their liability hedges
Ian Mills, Lane Clark Peacock
But October has seen yields rise steadily as prices fell, in response to broader market worries about a ‘hard Brexit’, and the inflationary pressure of a fall in the value of sterling.
For Chris Wagstaff, head of pensions and investment education at Columbia Threadneedle, the news, while positive, should be taken in the context of the year as a whole.
“For most schemes, a 1 per cent fall in yields equates to about a 20 per cent rise in liability values, so the recent uptick in gilt yields will provide some relief to those DB schemes that haven’t undertaken much, if any, liability hedging,” he said.
“However this must be seen against the backdrop of 10-year gilt yields having declined by 0.9 per cent year to date, which has resulted in a widening of DB scheme deficits at the triennial valuation.”
Trigger-happy investing
In addition to impacting funding levels, movements in gilt yields can also affect investment strategy. Rising yields mean gilt prices are falling, so schemes are able to derisk their assets at a lower cost.
Commenting on Mercer’s fiduciary business, European director of strategic research Phil Edwards said: “We have actually seen some schemes going through funding level triggers.”
But he stressed that trustees’ response to increases in gilt yields should be “scheme specific”, bearing in mind factors such as overall funding level and covenant strength.
“Many other schemes will still actually have a large funding gap,” he said.
He warned trustees not to try to guess future movements in the market, but rather to plan for a range of scenarios: “Predicting gilt yields at the moment is a dangerous game.”
Economic worries
Of course, rising gilt yields can also signal a rise in inflation, a suspicion confirmed by the news that the consumer price index has risen to 1 per cent. Fears of a ‘hard Brexit’ have also influenced this.
Ian Mills, partner in LCP’s investment practice, said: “We’ve seen expectations of long-term inflation... ticking up a bit and that has fed into the nominal gilt market.”
He said that while schemes may have hedged against rising inflation, they can still feel its impact via their corporate sponsors: “Most manufacturers and most importers of goods will be seeing their prices rise.”
He agreed that some triggers will have been activated by the recent move in yields, but noted that the change has been far more pronounced in the nominal gilt market than the index-linked market. “Where you have schemes that have fixed pension increases it’s certainly an opportunity for those schemes to increase their liability hedges,” he said.
