The UK asset-manager F&C publishes a quarterly index of pension funds› hedging activity, which it tracks by surveying staff on investment banks› dealing desks. It said that in the three months to June 30, funds bought £24m worth of interest-rate swaps – which will cover £9.3bn of their liabilities against movements in interest-rates.
Falling interest rates make pension funds› liabilities look bigger, which makes their deficits worse. As F&C notes: "Long-dated interest and inflation rates are frequently used as an economic measure of the present value of pension schemes’ future payments to members."
So those that covered themselves in the second quarter may be grateful. Real interest rates have been falling in June and July as the European sovereign debt crisis worsens, along with the outlook for the US economy. In response, investors have been dumping risk-assets like equities and piling into US government bonds, UK gilts and gold.
BlackRock, the US fund manager, said the effect is already being felt in the US — where liability values at US pension plans it tracks rose by 5.7% during July and are now up 6.8% during 2011. Asset values fell by 0.1% during July, but are still up 5% for the year.
About £85.5bn of UK pension liabilities have been hedged against interest-rate movements since F&C started tracking the numbers at the start of 2009. But compared to roughly £1 trillion of private-sector pensions liabilities, that is comparatively small beer.
Keith Guthrie, chief investment officer at Cardano, said he believed UK plans› funding ratios have already been reduced by about 5% in the past two months. A full-blown eurozone crisis could hit plan assets by up to 20%, he estimated, and cause liabilities to go up another 5%. He said: "Most UK pension funds remain heavily invested in equities and only hedge a small proportion of liability risks."
Cardano says that pension plans should cover themselves better, by hedging as much of their liabilities as they can against movements in interest-rates and inflation, and diversifying their assets into a broad "all weather" portfolio, rather than relying on equities.
