Key Takeaways
- • Pensions Week and schemeXpert.com surveyed 12 of the UK's highest-profile investment consultancies and found they have materially reassessed fixed income since the collapse of Lehman Brothers in 2008.
- • Consultants are focusing more on default risk and on the changing correlation between fixed income asset classes, and see new opportunities created by the financial crisis.
- • Liability matching has become more important: Karen Heaven of Redington said less well-matched schemes saw funding levels swing sharply with market volatility.
- • The sovereign debt crisis has ended the view that developed-market government bonds are a safe haven; consultants now assess individual country default risk on demographics, fiscal policy, natural resource access and trade balance.
- • Consultants are tightening government bond mandate guidelines to insulate schemes against default, while stronger-country bonds such as UK gilts are largely unchanged in their view.
Summary
UK investment consultants have turned away from traditional approaches to fixed income since the collapse of Lehman Brothers, according to a review of the country's leading advisers conducted by Pensions Week and schemeXpert.com. The survey covered 12 of the highest-profile UK investment consultancies and examined how attitudes have changed over the past three years. Pension schemes had grown convinced over the previous decade of the merits of using fixed income to match liabilities, but the 2008 financial crisis led consultants to re-evaluate the risks inherent in the asset class, including borrower defaults, central bank liquidity injections and corporate and sovereign instability.
Liability-driven investment, which uses fixed income to hedge scheme risks, was already popular before 2008, but the crisis made consultants more focused on managing liabilities effectively. Karen Heaven, vice president and investment consultant at Redington, said less well-matched schemes saw funding levels swing violently and negatively with market volatility, and that widening credit spreads masked the impact on the accounting basis but not the trustees' funding basis. Many consultants have warned schemes about unrewarded risks such as interest rate and inflation risk. David Clare, managing director at JLT Investment Consulting, cautioned that trustees should not use the strong historic returns of bonds, which benefited as yields fell to historic lows, to set strategy, as this raises regret risk if yields rise in an inflationary environment.
The sovereign debt crisis has been the most significant new concern. Most consultants said it caused them to reappraise the default risk of individual countries, assessing demographics, fiscal policy, access to natural resources and trade balance. Claire Ballantyne, manager research analyst at Hymans Robertson, said the Greek, Irish and Portuguese bailouts exposed the risk of any borrower that does not control the currency of repayment. Matt Tickle, partner at Barnett Waddingham, said he now assesses all bonds on an "ability to repay" basis, noting that not all A-rated bonds are equal. Many consultants have not changed their view of stronger sovereigns such as UK gilts, though some noted that crisis-driven low yields make these bonds less attractive as an entry point. Consultants are advising clients to tighten government bond mandate guidelines. Bobby Riddaway, principal and senior investment consultant at Buck Consultants, said government bonds are not risk-free and that fixed income risks should be understood rather than treated as a simple matching asset.
The article is the first of four special reports on the topic.
Liability-driven investment, which uses fixed income to hedge scheme risks, was already popular before 2008, but the crisis made consultants more focused on managing liabilities effectively. Karen Heaven, vice president and investment consultant at Redington, said less well-matched schemes saw funding levels swing violently and negatively with market volatility, and that widening credit spreads masked the impact on the accounting basis but not the trustees' funding basis. Many consultants have warned schemes about unrewarded risks such as interest rate and inflation risk. David Clare, managing director at JLT Investment Consulting, cautioned that trustees should not use the strong historic returns of bonds, which benefited as yields fell to historic lows, to set strategy, as this raises regret risk if yields rise in an inflationary environment.
The sovereign debt crisis has been the most significant new concern. Most consultants said it caused them to reappraise the default risk of individual countries, assessing demographics, fiscal policy, access to natural resources and trade balance. Claire Ballantyne, manager research analyst at Hymans Robertson, said the Greek, Irish and Portuguese bailouts exposed the risk of any borrower that does not control the currency of repayment. Matt Tickle, partner at Barnett Waddingham, said he now assesses all bonds on an "ability to repay" basis, noting that not all A-rated bonds are equal. Many consultants have not changed their view of stronger sovereigns such as UK gilts, though some noted that crisis-driven low yields make these bonds less attractive as an entry point. Consultants are advising clients to tighten government bond mandate guidelines. Bobby Riddaway, principal and senior investment consultant at Buck Consultants, said government bonds are not risk-free and that fixed income risks should be understood rather than treated as a simple matching asset.
The article is the first of four special reports on the topic.
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