In the UK as a final salary pension fund you may be feeling as if you have just landed on a ladder and risen several rows on the board game closer to the finish, i.e. full funding.
The FTSE100 equity index had its best performing January since 1989 and the S&P500 has broken through the 14,000 level not reached since before the onset of the Global Financial Crisis in 2007. All of this is good news for pension funds invested in equities as their funding level will have improved significantly over the past few months.
In the US it appears as if many pension funds have landed on a “snake” as corporate after corporate announces significant cash injections to their underfunded pension funds. So much so that @blackbullion commented on Twitter: “isn't Detroit an underfunded pension fund that makes some cars?” in response to a tweet I posted on Ford’s $5billion funding of its pension fund. Ford isn’t alone in making significant cash contributions to its pension funds. It’s joined by other large US corporations Honeywell, Raytheon etc. - all of whom have stepped on the proverbial pensions snake.
The big question is what should you do next? This highlights the difference between an “outcome focused investment strategy” or a “peers based investment strategy”. An outcome focused pension fund will have clear goals & objectives combined with regular monitoring of its assets, liabilities, funding level and perhaps its ongoing required rate of return. They will likely focus on risk and return and see the recent strong outperformance of equities over liabilities (see chart) as an opportunity to take-profit i.e. bank the outperformance of their assets over their liabilities. If, however, you have peers based investment strategy and pay more focus to the value of your assets than your funding level, banking the outperformance may not feature in your risk management framework.
The chart below shows the relative value of equities to index linked gilts plotted against the PPF 7800 funding (link) ratio. The FTSE/Index-Linked Gilt ratio is calculated by taking the market level of the FTSE e.g. 6,000 divided by the price of the 2037 Index Linked Gilt e.g. 120. This gives you a ratio of 50. The FTSE/Index-Linked Gilt ratio can be enlightening as a “rule of thumb” proxy for pension funds’ decisions to switch between equity and fixed income. Opportunities to dynamically “take profit” out of equities and into index linked gilts to hedge the liabilities are highlighted at the peaks (1) and (2). The PPF 7800 Funding Ratio is given in the background to provide context of the relative performance of a large sample of pension funds.
Checklist for “taking profit” and dynamic risk management:
- Do you have clear goals and objectives?
- Do you have take profit triggers in place?
- Are they market yield based?
- Funding level based?
- Versus your “Flight Plan” and your “Required Rate of Return”?
- Do you have regular monitoring in place to capture these opportunities?
- Do you have the governance and delegation to be agile and take advantage of these opportunities?
Which is better? No one knows. We are all faced with the same financial uncertainty. However if you had the opportunity to remove the big snake on the final row to the finish in exchange for removing one ladder from the board – would you?
My view is that repairing the deficit and improving the security of the pensioners through prudent and disciplined risk management is the best way forward.
Happy to discuss, please do get in touch to find out more.
Please note that all opinions expressed in this blog are the author’s own and do not constitute investment advice. Click here for full disclaimer