UK election: Rising interest rates could help cut DB liabilities
Uncertainty following the UK election could have a longer-term positive effect on UK pension scheme liabilities if it forces interest rates higher, according to the CEO of Hermes Investment Management.
The Conservative Party, which lost 13 seats despite being expected to win comfortably, is planning a coalition with Northern Ireland’s Democratic Unionist Party (DUP).
But Saker Nusseibeh, who leads the asset manager wholly owned by the BT Pension Scheme, said concessions on public spending could lead to higher inflation and higher interest rates – the latter of which will push down defined benefit (DB) scheme liabilities.
The yield on 10-year government bonds fell below 1% around 5am UK time this morning as the election result became clear. It had risen to 1.03% by mid-afternoon. This is nearly double the record-low yield of 0.52% reached in August.
“In general, rising gilt yields reduce long-term liabilities,” Nusseibeh told IPE. “The question is how much have schemes locked in against rate rises? If you have, then you could be in a bad place.”
Commentators have speculated that the Conservative Party may have to make concessions on public spending in order to gain support from the UK parliament, in particular the DUP. Gregg McClymont, head of retirement savings at Aberdeen Asset Management and a former Labour Party pensions spokesman, suggested the unexpected gains made by Labour were part of an anti-austerity vote from some parts of the electorate.
Bill Street, head of investment for EMEA at State Street Global Advisors, said: “As the market prices in campaign promises of fiscal stimulus and a softer-Brexit, we believe that gilt yields could be on course for a sustained upward move over the medium term.”
David Page, senior economist at AXA Investment Managers, said gilts “could remain vulnerable to any shift in government policy if it loosens fiscal policy in response to this election”.
Paul Flood, multi-asset portfolio manager at Newton Investment Management, pointed to inflation-linked investments such as renewable energy assets as also benefiting from the uncertainty.
These would outperform government bonds, he argued, which were “likely to come under pressure as lower economic growth leads to higher government borrowing against a more inflationary pressures from a weaker currency”.
Any shift downwards in liabilities for UK schemes will come as welcome news to trustees and sponsors.
According to the Pension Protection Fund’s 7800 index of DB schemes, there was an aggregate shortfall of £246bn (€280bn) across all private sector schemes at the end of April.
More recent data from the end of May has put this shortfall at £183bn (according to JLT Employee Benefits), or as much as £510bn (PwC).