The essayist Robert Wilson Lynd wrote that “belief in the possibility of a short decisive war appears to be one of the most ancient and dangerous of human illusions”. The twentieth century conclusively laid to rest the notion that wars between nations would end with the symbolic exchange of border provinces or notional reparations. The economic consequences of the First World War were profound and long lasting, just as the Second World War shaped politics in ways we still see today.
Similarly, this century is providing evidence that there will be no rapid return to business as usual in markets. This has strong consequences for pension funds, sponsors and the shareholders of sponsoring companies, as well as for the asset managers who manage pension assets.
We have now passed the fourth anniversary of the Lehman collapse, the now emblematic event that triggered the Great Recession and the ongoing crisis whose latest manifestation is the euro debt crisis.
The massive housing credit bubble that was behind the collapse of Lehman was no isolated case. Europe, as we now painfully understand, was also not immune from the property lending bubble, particularly Ireland and Spain. It was unfortunate for the architects of the euro, and for everyone else, that the advent of the single currency in part coincided with this expansion in credit and in part caused it in the form of unsustainably low interest rates in those countries. The Mediterranean euro members also neglected to promote productivity and employment, which would have helped sustain healthy government finances over the longer term.
There has been considerable deployment of heavy weaponry since Lehman. The Bank of England claims in its recent paper ‘The Distributional Effects of Asset Purchases’ that its £375bn (€464bn) quantitative easing programme has had a broadly neutral effect. Yet the bank admits that UK defined benefit schemes in “substantial deficit” before the crisis have seen an increase in those deficits. This masks the fact the vast swathe of UK DB schemes have experienced a painful increase in liabilities, and a drop in funding levels, since the onset of the crisis.
According to the latest figures from the UK Pension Protection Fund, the aggregate deficit of UK pension funds in the PPF 7800 index was £280bn (€346bn), while in December 2007 there was a surplus of £11.7bn. For those funds that did not hedge their liabilities when in surplus, it would have been a dangerous assumption that things would snap back to pre-crisis normality.
The effect of continued and painful low yields in safe-haven European debt, along with low asset returns and a demographic squeeze, has been similar among pension funds elsewhere in Europe. But while Dutch pension funds, courtesy of the DNB regulator, have an in-built haircut mechanism in the form of benefits cuts, there is currently no such equivalent in the UK, apart from the necessarily limited mechanism of the Pension Protection Fund.
There is a wider reason to note the deficits of corporate pension funds. According to Morgan Stanley, its two stock baskets of UK and European companies with the biggest pension deficits have underperformed by 27% since September 2009. And, as it notes, pension accounting changes under IAS19 will have a considerable negative effect on corporate earning from next year.
This in itself underlines that banks increasingly have companies’ pension deficits in their sights, which gives greater impetus to financial directors to ensure trustees have sound hedging policies in place, as well as to make good deficits over the medium term. In some cases, all to the better, it may spur them to increase the resources available to the pension fund in terms of personnel, in recognition of the important role the fund plays at the overall corporate level.
The war of attrition of demographics, volatile markets and low interest rates shows no sign of abating and a comprehensive ‘peace settlement’ is some way off in this long campaign.