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Pensions liabilities should be discounted against non-bonds – SPC

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  • Pensions liabilities should be discounted against non-bonds – SPC

UK - Pension liabilities should no longer strictly be measured against bond yields, according to the Society of Pension Consultants (SPC), which argued in favour of bond-like assets being taken into consideration when assessing a scheme's health.

Speaking at the launch of its White Paper - Vision 2020 - society president Roger Mattingly also discussed the potential of smoothing the yield curve - although he conceded that the UK would likely have to consider a one-year smoothing approach, as the three-month approach adopted by the Netherlands would not make "a blind bit of difference".

Mattingly also called for a more cohesive pensions strategy from the government, criticising the lack of an overall plan for reform, but praising the fact that many recent changes had enjoyed cross-party support.

Natalie WinterFrost, member of SPC's investment council, meanwhile called for a re-evaluation of the way liabilities are measured in the UK regulatory environment in the wake of 10-year gilt yields falling as low as 1.52 early last month and down by nearly 50% year-on-year.

"What you are doing [with] bond-based discounting is akin to an uninvestible benchmark - it is not a great situation to be in," she said.

"We need to move up the agenda a re-evaluation methodology, and possibilities might be to recognise other cashflow-matching assets as matching liabilities, and potentially net them off against liabilities."

She said this would "obviously" need to be done in a thought-out way, with security behind the cashflow, if it were to net off against the liability rather than appearing on a company's balance sheet.

"But there are attractive asset classes that do throw off bond-like cashflows," she noted.

She added that the UK bond market was too small to address domestic schemes' demand, with the SPC estimating annual new demand at nearly 35% for both index-linked and regular gilts as schemes were forced to shift to de-risking strategies as a result of regulatory changes.

While welcoming the National Association of Pension Funds' plans for a Pension Infrastructure Platform, WinterFrost said any returns offered through such an infrastructure vehicle would, at first, be more akin to equity returns due to the construction phase of any projects.

She said the later, more stable returns offered by completed projects would be more suitable.

However, she argued that social housing was a serious contender - offering pension funds suitable returns.

Discussing the severe impact of the current low-yield environment - partially triggered by repeated bouts of quantitative easing, partially by the UK's status as a safe haven - Mattingly was insistent on swift action.

"I know recovery rates have been looked at by the regulator," he said, referring to the Pensions Regulator's April guidance on how deficit funding would be treated in the current climate.

"But they need to adapt that measurement and have something in place that is contemporary, more suitable and doesn't drain the lifeblood from the economic growth of UK plc.

"It is needed, and it can't really wait until next April."

WinterFrost also discussed the problems facing the Debt Management Office when auctioning long-dated paper, saying demand was not always sufficient and suggesting that alternative methods to traditional bond auctions should be explored to soak up some UK scheme demand.

"Given how much is needed and the fact the existing mechanisms for coming to market with that supply aren't working, they really need to rethink," she said.

She said one option, previously dismissed by the DMO, could be direct placement schemes, with funds registering their interest in volume and length of issuance.

Discussing whether such on-demand issuances should strictly be of existing bonds, or whether the DMO should consider a paper tailored to pension fund demands, WinterFrost said the ideal issuance would be a longevity bond, but that it would not happen.

"The DMO is quite keen to ensure that any bond tranche they issue has liquidity and marketability and, actually, it's very unlikely that any instrument that's really a good match for pension liabilities would meet those criteria," she said.

However, she added that there was likely no big demand for longevity or limited prices indexation bonds, as liabilities could be adequately hedged through existing fixed income and inflationary assets.

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