UK – Investors are increasingly taking into account the pension fund position of a company as an indicator of financial health - resulting in a downward spiral of financial markets, says Newton Investment Management.

“Stocks and bonds are now inextricably linked via the emergence of pension fund liabilities,” says Newton’s Stewart Cowley.

The huge pension funding holes publicised over the last six months have drawn investors’ attention to the role of pensions as an indicator of financial health, says Cowley, investment leader, global bonds, at the firm.

Aerospace firm Rolls Royce, for example, has a pension deficit of 1.5 billion pounds (2.15 billion euros) – just under its 2.17 billion-pound market value.

Pension fund deficits should, therefore, be reflected in the financial viability of a company. For instance, says Cowley, if Company X has a market value of 10 billion pounds, and a pension deficit of two billion pounds, then this reduces the equity value of the company by some 20% over time.

Cowley says this is creating a downward spiral for the equity markets. As stock markets fall, so deficits increase as UK pension funds rely heavily on equities, further eroding investor appetite for equities and leading to further stock market falls.

Instead of equities, investors are now choosing to invest in fixed income, and the excess demand is pushing yields to new lows in the medium term. It is therefore, very difficult to escape from the low-return environment.

Bringing an end to the downward spiral, and escaping the low-return environment could take years, Cowley believes. “Money will have to be thrown at the problem and the funding holes plugged, but with bond returns so low, this could take many years.”

Newton is one of Mellon Global Investments’ investment management businesses.