Flight paths on cruise control – but watch out for turbulence

January 8, 2014 Categories: Uncategorized


This time last year I blogged about pension plans sitting on the runway Waiting to take off.

Although many had flight plans in place, few were making switches from growth to liability hedging assets. Derisking had stalled in the face of low interest rates, meaning that the price for hedging liabilities was at an historic high.

One year on and many plans have made some progress down their flight paths. Exuberant stock markets have pushed funding levels up, so that plans could afford to make switches from growth to liability-matching assets. Around a third of our Fiduciary Management clients managed not only to recover their losses from 2011 and 2012, but to push on through to their next funding level trigger and make a further switch. But as my colleague Andrew Pease points out in 2014: A year for investing cautiously we think equity returns in 2014 will be more modest, validating the 2013 rally rather than continuing it.

We still have the challenge of low interest rates.  But with the Fed now having sounded the bell on its massive program of monetary easing, we have the prospect of rising interest rates over the course of 2014.  Much of this is already priced in: using Bloomberg mid-market yield levels as of the open this year, the yield on 10 year interest UK 10-year gilts was expected to rise from 3.0% to 3.4% in one year’s time. We think that 10 year yields will end the year in the range 3.0%-3.5%, broadly in line with current market expectations.

Great news, you might say, for pension funds, many of which have been waiting for a very long time for interest rates to rise, and hope to see their liabilities fall as interest rates rise. Unfortunately, this will only happen in yields rise faster than the market expects, as I discussed in a recent article Concerns of interest rates is putting schemes off LDI.

So if 2013 gave us take-off, 2014 looks set to be a year of cruise control. All the good news heralded by a return to health of the world’s major economies has already been priced in to both equity and bond markets.

But there is the potential for turbulence. Extra volatility, especially in bond markets, is a good bet. Equity markets may overreach themselves. That turbulence may create opportunities for pension funds that are able to act nimbly.

Our advice:

  • Don’t delay in building your liability hedging programs now [more on this in an upcoming blog from Gwion Moore].
  • Be ready to take advantage of market volatility on the upside.
  • Think about how to protect on the downside [watch out for more on this in an upcoming blog from David Vickers].

Sorca Kelly-Scholte – Managing Director, Client Strategies & Research, EMEA

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