What the BoE base rate cut means for pension schemes
The recent cut in the Bank of England base rate has highlighted that pension schemes should not be relying on gilt yields returning to previously higher levels any time soon. The action to stimulate economic growth could lead to higher medium term yields (10 years or more) in time, if it works, but the timing of the effect of such a stimulus is extremely hard to predict. Pension funds could therefore be faced with lower funding levels if yields continue to decline and they take no action. In addition, gilt volatility may see short term spikes in gilt rates.
As a result, pension schemes may fall into one of two camps.
There will be those that cannot afford to reduce their investment in risk assets, such as equities, as they are relying on their higher expected returns to partly fund their pension costs. However, such schemes may take advantage of certain asset classes which will protect them from further interest rate falls without necessarily reducing their expected returns. In the past these asset classes were only available to the largest (£1bn+) pension schemes. However, funds launched in recent years now make them accessible to smaller schemes (£10m or even smaller), and offer the necessary training to understand how they operate.
For schemes not wishing to make use of such funds, and perhaps wanting to wait for a potential rise in gilt yields, then they should monitor their funding level closely so that any opportunities for them to take risk off the table are spotted quickly. These opportunities could come from risky assets rising in value, or from gilt yields rising. To do this effectively, you need to monitor the position on a daily basis and be ready to act promptly. Again, this facility previously tended to only be available to the largest schemes, or those schemes that delegated their investments to parties such as Fiduciary managers. However, Capita has provided this service to schemes from £10m upward for over four years and are seeing an increasing number of schemes taking this up, as well as upgrading the service to allow Trustees to also track their funding level on the internet.