Real Returns by Dan Mikulskis

The PPF today published its monthly estimates of scheme funding position for the schemes in the PPF 7800 index.

Not surprisingly, given the market moves over September 2015, and over the third quarter generally we saw a 5% decline in funded status over the quarter due to both declining asset values and increasing liabilities.

It’s been a bumpy ride for pension schemes over the last year as the liability side of pension scheme balance sheets have been impacted by volatile and falling gilt yields, while the asset side has now been hit by the equity market volatility we’ve seen through August and September.

Both the funding position (79.9%) and deficit (at £311.7bn) are close to the January 2015 positions, which were the worst in the 10-year history of the dataset.

What does this mean for most pension funds?

The major impact this will have on a pension fund will be the Required Return they need to become fully funded over the target investment horizon of the scheme (which will vary).

Roughly speaking a 5% worsening in funding level might equate to a 0.5% per annum increase in required return over, say, a 15 year investment horizon. It would mean a significantly higher increase in required return over a short time horizon of 10 years or less (see figure 1)

If the expected returns from the assets are held constant then a 5% fall in funding level would push the full funding date out by around 5 years (see figure 3).

Following these falls, what should pension schemes do? 

• Revisit their funding goals, and ask whether these are still achievable;
• Check the investment strategy is on track to meet the returns they need;
• Avoid knee-jerk reactions by sticking to a decision making framework.