Brexit will have a substantial impact on the lives of people across the UK, and one area where its effects are already being felt is in the pensions industry. Since 24 June, financial markets have been in risk-off mode. Investors have dumped equities and risky assets in favour of assets that are perceived to have less risk such as government bonds and gold.
This sudden rush towards government securities has pushed down yields, (as bond prices rise, yields fall) which is great news for borrowers but bad news for bond investors who are now getting a lower return on their investment.
More for less
The single largest buyers of government bonds (excluding central banks via QE) are pension funds. The high quality and long-term nature of government bonds makes them the perfect assets for pension funds that have to match today’s inflows from contributors to future liabilities or pension outflows.
With yields falling this task of matching inflows with future outflows is becoming harder and harder. Most pension funds target a return of 5% to 10% a year on their assets. With most government bonds now yielding less than 2%, it’s easy to see the scale of the problem facing the industry.
Defined benefit funds are the most at risk. According to research from Bank of America at the end of April, the average funded ratio of the top 100 US corporate defined benefit pension plans sat at 77%, and this figure was calculated before the post-Brexit yield slump. The funding ratio of 77% indicates that the $3trn pension universe surveyed is running a $500bn funding gap.
Unsustainable deficit
Here in the UK, it’s estimated that 11m people are reliant on defined benefit pension schemes and after recent market movements it’s estimated that UK pension deficits hit a record £935bn this week.
There’s no doubt that this is a colossal sum and meeting these liabilities is going to cause a serious headache for the worst-offending companies.
For example, BT’s pension deficit has increased by more than 50% in 18 months (to the end of May). Analysts at investment bank Macquarie believe the deficit now stands at £10.6bn. To put this figure into some perspective in the year to 31 March 2016, BT reported a pre-tax profit of £2.6bn. Macquarie believes that considering the present deficit, BT will have to pay £1bn per annum through to 2030 to fill the pension black hole.
The big question now being asked is, will companies ever be out to meet these pension liabilities?
Unfortunately, there’s now a very real chance that many businesses won’t be able to meet these obligations as deficits at some companies eclipse profits. Meanwhile, the UK’s Pension Protection Fund, a government-sponsored lifeboat for collapsed pension schemes, only has a funding surplus of £4.8bn, that’s just 0.51% of the total value of pension deficits as reported last week.
The figures really speak for themselves. The UK’s pension deficit is only getting worse, and there seems to be no way out.
Protect yourself
The best way to protect yourself from the upcoming pensions bombshell could be to look after your own pension by investing in shares. And the best way to invest for the highest return is to look to high-quality blue chips with international operations, sustainable dividends and records of achieving the best returns for investors. Companies such as Unilever, AstraZeneca and GlaxoSmithKline all meet these criteria, but there are many more.
