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QE impact on pension funds "exaggerated"

02 November 2012

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The overall impact of quantitative easing (QE) on pension funds has been "exaggerated" according to consultancy firm Towers Watson.

The firm suggests that since the start of the credit crisis in 2007, UK index-linked gilt (ILG) yields have declined only marginally more than comparable government bond yields in other countries, where there has been no QE.

The consultant also notes that the price of risky assets has risen significantly during each period of QE, which has dampened the impact on pension fund balance sheets. In addition, it asserts QE is likely to have averted a bigger economic downturn, and the consequent failure of more pension fund sponsors, and in the process benefited the Pension Protection Fund (PPF) as well as giving pension funds extra time to execute journey plans. In a statement the firm says that UK pension funds should "not wait for a recovery before de-risking". 

Alasdair MacDonald, head of investment strategy at Towers Watson, said: "Many commentators are suggesting that QE by the Bank of England (BoE) has led to a significant fall in ILG yields and pension funds need simply to weather the current storm of low gilt yields for a few years, before they are able to de-risk at much more attractive terms. We do not share this view and would urge funds not to use this as an excuse for inaction.

"The effect so far of QE on UK pension funds needs to be viewed holistically, and while the recent BoE figures are a helpful upper estimate of the impact on bond yields, they make no allowance for what might have happened anyway without QE."

The views of Towers Watson are not shared by organisations such as the National Association of Pension Funds (NAPF), Legal & General Investment Management and the Pension Corporation which in the past have told Pension Funds Insider that the controversial measure intended to save the frail state of the UK economy has brought unwelcome extra liabilities to pension scheme balance sheets. With bond yields dropping as the bank buys up gilts, the NAPF says that schemes already have and will continue to see, their incomes drop considerably compared to their liabilities.

Shalin Bhagwan, head of structuring in the Liability Driven Investment Funds unit at Legal & General Investment Management, told Pension Funds Insider that QE put a strain on schemes "when they can least afford it".

"There is a dichotomy going on, cash rich schemes will be fine but others will feel the extra pressure," he said. "Is the government really trying to stop schemes from buying bonds and move them to more riskier assets such as equities?"

Towers Watson in return now says that the low bond yields partly reflect investor concern about the Eurozone and the impact that a breakup would have. It says if funds view a Eurozone crisis as particularly likely or have a sponsoring employer that is heavily exposed to Europe, then de-risking now can ensure that the pension fund remains solvent until markets become more rational.

MacDonald said: "Drawing on Keynes' view that markets can remain irrational for longer than an investor can remain solvent, pension funds must consider that there is a chance that yields do not recover from current levels and developed markets repeat the experience of Japan. We believe that there is a 20% chance of this occurring and a scenario that should concern many trustees."

The firm's global investment committee says that the other 80% of the time, risky assets are doing well, yields are rising and the pension fund sponsor is at least staying in business or growing. It asserts that losing money in this scenario, from having needlessly de-risked, will be far less painful to trustee and sponsors than suffering from not de-risking in the other scenario.

"A better reason for inaction is the profusion of de-risking options available to UK pension fund trustees at the current time," MacDonald said. "It is only right that pension funds move forward once they have fully considered all the options open to them and it is incumbent on the industry to develop more efficient ways of analysing and presenting all these options in a comparable way." 


First published 29.10.2012