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Study queries pension fund-low yield link

GLOBAL – A new academic study has questioned the notion that pension funds shifting into bonds will inevitably lead to long-term low bond yields.

And the authors put forward a “wildly far-fetched” approach to dealing with the mismatch in fixed income demand and supply.

David Miles, UK chief economist at Morgan Stanley, and his colleague Melanie Baker say that potential long-term thinking by both bond investors and issuers “should make us sceptical that the pension fund re-balancing story has as its inevitable conclusion that bond yields should be unusually low now and will stay unusually low”.

The authors make the comments in an article on the UK situation called ‘Real Yields, Pensions and Shifts in Demand for Bonds’ which appears in the latest edition of the Morgan Stanley Pensions Quarterly.

“We assess whether the scale of current, and future, demand for long duration, fixed income assets from pension funds could be the key factor behind unusually low levels of bond yields,” the authors state. They have developed a forward-looking model of aggregate pension fund assets and liabilities.

This model leads them to challenge the notion of continually higher scheme demand for bonds and lower bond yields.

They write: “So following a period of about 10 years of very strong overall net purchases of bonds from DB and DC funds in aggregate we project that this is followed by a very prolonged period (lasting from about 2014 for several decades) where there is very substantially lower, and falling, demand.”

For the first 10 years of their projections, both DB and DC are net sellers of equities.

The authors have put forward what they acknowledge is a seemingly “wildly far-fetched” solution to the problem of bond demand outstripping supply in the next few years.

“A radical way forward is for the UK corporate sector to simply sell their cross-holdings of equity held within their pension funds and increase their pension funds and increase correspondingly their cross-holdings of corporate debt instead.”

They argue the “scope for UK pension funds to play this game is enormous”. Although it appears to involve a £250bn expansion in the stock of corporate debt, the authors say the idea could work.

“Seen as one arm of a two-part switch in consolidated balance sheets it makes much more sense.”

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