DB schemes might be too dismissive of investment as a way out of deficits

The timing couldn’t be worse for any pension schemes that have just completed their triennial valuations.

Gilt yields stubbornly remain at record lows and the chance of hitting previously agreed funding targets looks fanciful.

London Stock Exchange

Consultant Towers Watson says employers may have to double their contributions to defined benefit schemes if they are to remain on track, or the alternative is to push back solvency deadlines by as much as a decade.

A fairly unpalatable dilemma.

The positive in all this is the government’s desire to see a more sympathetic approach from The Pensions Regulator to funding schedules, as announced in this year’s Budget.

When companies think about their red lines for negotiations with trustees, they will be well aware that the government appears to be striking up a more employer-friendly tune

However, John Ball, head of UK pensions at Towers Watson, said the current low interest rates mean “a baptism of fire” for the new softly, softly regulatory approach, adding: “The significance of [the government’s] announcement probably has as much to do with the tone as the content. When companies think about their red lines for negotiations with trustees, they will be well aware that the government appears to be striking up a more employer-friendly tune.”

And this pro-sponsor background music is already taking effect.

The most likely course of action for schemes tackling deficits is to extend funding schedules

Aon Hewitt’s Global Pension Risk Survey 2013, which covers 200 schemes worth £300bn, reveals the most likely course of action for schemes tackling deficits is to extend funding schedules (57% of respondents).

However, just over half (51%) said they would increase employer contributions, suggesting sponsors and trustees still see this as an important means of repairing funding holes.

Interestingly, there seems to be less focus on investment as a way out of the quagmire.

Just 45% said they would better diversify investments, 24% said they would accelerate de-risking, 13% would slow down de-risking and 9% would take more risk.

Equities have performed strongly yet 36% of respondents to Aon Hewitt’s survey said they will decrease stock market investment

Given that DB sponsors have poured millions of pounds into their schemes in recent years yet seen little impact on deficits, this begs the question should more be made of investment strategy?

Since 2009 equities have performed strongly yet 36% of respondents to Aon Hewitt’s survey said they will decrease stock market investment. At the same time 6% said they will increase investment in index-linked gilts.

When a valuation shows a significant deficit moving out of equities and ploughing into gilts makes no sense, particularly when stock markets are rising, as they have been for five years, and gilt yields are falling.  

No one is suggesting a return to the bad old days of 80/20 equity/bond splits

Using a disciplined approach and a having a greater appreciation of risk, means today’s DB funds can be nimble enough to lock in gains and use equity investment as a genuine means of deficit repair.

No one is suggesting a return to the bad old days of 80/20 equity/bond splits but the mass migration away from equities may need to be revisited.

DB schemes do not need to reinvent the wheel; a healthy allocation to equities as part of a diversified portfolio is nothing new but it may be in danger of being unfairly forgotten.