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UK funds hit by bond rates

British pension funds are facing gaping pension deficits because of record recent falls in longer-dated index-linked UK bond yields.
The value of pension fund liabilities - which has to be shown on company balance sheets - is calculated using a discount rate based on bond yields. The squeeze on yields has increased these liabilities, and a vicious circle has emerged with pension funds buying more gilts to compensate, which in turn has forced up gilt prices and reduced yields even further.
As funds grapple to plug the gap, Bob Scott, partner with actuaries and consultants Lane Clark & Peacock, says: “There are only three places they can get money to pay benefits from – funds they already have, investment returns on those funds, and future contributions. It’s only the last two they can do something about. And companies are already putting in substantial contributions.”
Scott says that if companies want to earn extra returns on their assets, they need to take extra risks.
“That implies a greater weighting in equities than in bonds, but that goes against the trend for recent years,” he says. “It is difficult to see funds reversing that. I think it is more likely that people will say, ‘Yields can go up again, and we’re in this for the longer term.’”

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