Companies with high pension deficits could see their stock prices outperform if bond yields continue to rise, a strategist has predicted.
Ankit Gheedia, European equity and derivative strategist at BNP Paribas, argued in a strategy note that a basket of 40 European companies with the highest pension deficits relative to their market capitalisation would outperform European equity indices if liabilities fell this year.
“Since August, credit yields have risen sharply amid the global bond market sell-off,” Gheedia said.
“Higher yields should be a relief for pan-European companies struggling with pension deficits as a result of low interest rates, and we expect a reversal in the pension liability trend as yields climb back up to pre-Brexit levels.”
UK 10-year government bond yields have risen from an all-time low of 0.518% in mid-August to 1.335% on 4 January.
BNP Paribas strategists have predicted a continued rise towards 2.15%, which Gheedia said should push corporate bond yields higher.
“This could drive a substantial reduction in the pension deficit reported by companies during the latest earning season,” he said.
Companies in BNP Paribas’s ‘Pension Deficit Basket’ had an average pension shortfall of 37% of market capitalisation.
The basket included a significant exposure to industrial, material and consumer discretionary companies.
Gheedia reported that the stocks were valued at “near three-year low levels”.
A number of reports in recent years have sought to highlight the danger to shareholders posed by sponsors’ obligations to large pension funds.
For example, a 2014 study by Pension Insurance Corporation and Llewellyn Consulting found that, for every £100 (€117) increase in a FTSE 100 company’s reported pension deficit, its market capitalisation declined by £160.
The study said: “The implication is that reported pension liabilities are regarded by markets as being systematically undervalued; that markets give larger weight to pension liabilities than to pension assets; and/or that a higher level of liabilities is viewed as representing a higher risk.”