Log inThe UK and your pension funds – headline vs reality – Market Update from Jilly Mann
Firstly, I want to immediately reassure our clients that despite the headlines which have emerged in the last 24 hours stating that UK pension funds are in trouble, the pension funds which are invested with Telford Mann are not caught up in this tumult.
In this Market Update I want to cover 2 important points,
- Are Pension Funds in trouble?
- The importance of maintaining defensive strategies during this period of uncertainty
Are Pension Funds in trouble?
I appreciate that it is not clear who or what is affected by the noises coming out of the Bank of England, but there is a very distinct type of pension which is the target of these headlines and that pension type is a Final Salary Scheme, otherwise known as a Defined Benefit pension arrangement.
Whilst some of our clients have been members of Final Salary pension schemes through their employers over the years, we do not manage these types of assets on behalf of our clients.
The personal pension or SIPP arrangements which we manage on behalf of clients have a very different structure to Final Salary pension schemes and so, whilst general movements in stock markets will impact valuations on a daily basis, they are not the pension schemes impacted directly by the Bank of England’s latest announcements.
I mentioned in my last market update that the Bank of England and the UK Government could be heading for a tussle over the Government’s growth strategy, sticky inflation and rising interest rates. At the time, Andrew Bailey, the Governor of the Bank of England, seemed to win some favour by stepping in swiftly to announce support for the UK bond market. This action stopped the Pound falling and did seem to provide an underpin to markets; equity, bond and currency markets alike.
I referenced the need for clarity in the message coming out of the Government and Bank of England over future monetary strategy. We did seem to have some clarity in the immediate aftermath of the Government’s mini-Budget, but sadly, Andrew Bailey has reverted more to type this week and has undone the reassuring work which had been done previously.
Quite why he felt a speech in New York with equity markets globally still struggling was the opportune time to essentially threaten UK pension funds will be analysed for days to come, but the impact has not been positive.
There are rumours that perhaps he had offered to underpin the Bond market by agreeing to buy more Gilts, effectively continuing Quantitative Easing, in return for UK pension funds also buying more Gilts. Maybe, the pension funds haven’t reciprocated the support by following through with those purchases and he felt the need to publicly force the issue.
Gilts are regarded as the most secure asset in the UK after cash. They are Fixed Income assets issued by the UK Government and have been the fulcrum of every economic event since the Global Financial Crisis in 2008. Every time the economy needs stabilising, Central Banks (not just the UK) use Government funded debt to stabilise the economy and underpin currency.
Final Salary pension funds typically own a vast amount of Gilts. They are directly impacted whenever the price of Gilts rise or the value of Gilts fall. The reason why Final Salary pension schemes own Gilts and other such Fixed Interest assets is because the pension schemes have known liabilities. They know that they have to provide an income to multiple pensioners in the future who are reliant on their Final Salary pension scheme to fund their retirement. Therefore, fixed interest assets with a known income associated with them and a fixed maturity date have been the staple asset of Final Salary pension funds for years. This is not a new phenomenon.
The problem facing Final Salary pension funds currently is that the value of Gilts has been falling (see chart below showing how Gilts have fallen in value over recent weeks) following similar falls in the value of Sterling. The reason for the falls reflects a lack of confidence in the Government’s ability to balance the books given the recently announced plans to cut taxes.
This creates a problem for the pension schemes because historically they have been able to rely upon the certainty and stability of Gilts within the funds they hold, allowing them to leverage that stability to create additional revenue. However, with the value of Gilts falling, that leverage is working against them and the schemes are facing shortfalls. This in turn forces them to sell Gilts to provide liquidity which in turn weakens Gilts even further.
Given the millions of pounds wrapped up in Final Salary pension schemes, even a small movement up or down in the value of Gilts has a massive impact.
Final Salary pension funds have faced funding shortfall issues for a number of years and so managing this risk is always at the forefront of Pension Trustee meetings. In addition, there are a number of measures in place that Pension Trustees have to meet in order to demonstrate that the pension scheme is able to fund its liabilities, i.e. income for pensioners.
Fortunately for our clients as investors in SIPPs or personal pensions, these issues don’t exist. Those pensions are managed individually by us and not by some remote Pension Trustee. Retirement income with us is ordained by our clients themselves rather than being reliant on the Pension Scheme Trustees or the price of Gilts.
It is a shame that these headlines are taking precedence at the moment as they are giving a false impression about which pensions are affected by the Bank of England’s announcements. They also lump all Final Salary pension schemes together which is unfair as Final Salary pension schemes are the envy of many, with many managed very successfully and again unaffected by the headline news.
It remains to be seen if the Bank of England will follow through with their intention to stop buying Gilts on Friday 14th October and essentially stop underpinning the economy. If it does that without intervention between now and then, we can expect the currency markets to react negatively and other global powers to raise further concerns about the UK’s economic credibility.
One could argue that the Bank of England will lose credibility if they don’t stick to their original timetable of the end of this week for withdrawing support, but given the circumstances, it is hard to see where the upside for withdrawing support outweighs the potential downside risks.
We are entering the tussle period between the Bank of England and the UK Government which we feared would happen. Initial impressions were that we could avoid this situation, but the Bank of England has flexed its muscles.
I would expect further announcements between now and Friday, because although it seems irresponsible to follow through with Andrew Bailey’s plan and whilst we know the potential consequences, that doesn’t mean that they won’t do it.
The importance of maintaining defensive strategies during this period of uncertainty
One change that we made a few weeks back was to sell the L&G UK Property fund. Whilst this fund itself remains unaffected, we have today seen further announcements of UK property funds delaying redemptions for investors looking to sell down. The CT UK Property fund we still own is also unaffected and open for business, in fact it is receiving positive inflows, but I wanted to highlight that there are a lot of potential knock on effects for investors at the moment and we are trying to stay one step ahead at each juncture. If you read headlines concerning UK property funds, please be assured that your investments remain unaffected.
We have made further changes to the portfolios and we continue to do so whilst this situation rumbles on, maintaining the defensive strategies that we have had in place for some time now. Portfolios have slipped a little in recent days, they are still outperforming the wider markets quite considerably and remain well ahead of benchmark (see chart above), but right now our focus is on trying to second guess the next economic moves in the UK and ensure that investors remain as insulated as possible from any wider economic uncertainty.