UK companies whose pension schemes continue to hold their current gilt portfolio could be foregoing a potential saving of around £20bn over the next decade, according to new research by PwC.
The eurozone crisis and the Government’s quantitative easing programme has forced UK gilt yields to historic lows and has left pension schemes holding billions of pounds of gilts at arguably inflated values.
According to PwC, now is the time for pension scheme sponsors and trustees to re-examine if the gilts they hold are still fit for purpose, or whether gains made to date should be banked and used to purchase assets which could lead to improved investment returns. Alternatively, many UK pension schemes holding gilts may also be in a position to swap them for an asset, such as a buy-in policy, that more closely matches their liabilities. This buying-in of annuities will give pension scheme trustees an asset that combines a financial hedge with protection against demographic risks including longevity.
However, the full value of these opportunities may begin to erode as pension schemes start to act. Early movers, therefore, stand to realise the optimal benefit. Clearly, individual schemes will have their own risk versus reward criteria.
Raj Mody, head of pensions at PwC, said:
“While there were compelling reasons for schemes to hold gilts in the past, the financial crisis, quantitative easing and eurozone troubles have meant gilt returns have kept falling and are now at historically low levels. With another round of quantitative easing announced, sponsors and pension trustees need to ask themselves whether holding gilts is still the best option, depending on their attitude to risk and return.
“Schemes which swap gilts for corporate bonds, or a mix of corporate bonds and gilt repos, ahead of the pack could provide a much-needed boost for their investment returns and so a reduction in additional cash contributions required. In some cases, deficit repair contributions could reduce by more than a quarter.”
Returns on longer-dated gilt yields have fallen dramatically in the last two years. For example, an investor buying a 2060 fixed-interest gilt today would lock into a return of around 3.2% a year, which is down 1.1% a year from the return on the same bond last summer, before the second round of quantitative easing and the worsening of the eurozone crisis.
Clearly, each scheme’s circumstances are unique and detailed advice is essential in this area.
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