The Chancellor’s mini-budget has led to major market reactions.
Among the greatest concerns is the health and stability of pension funds, with markets suffering significant hits from worried investors and the Bank of England forced to step in to purchase Government bonds. However, Andrew Clare, Professor of Asset Management at Bayes Business School believes these worries are overstated.
“There has been a great deal of hyperbole with regard to pension fund finances recently,” Professor Clare said.
“It is true that pension fund trustees and their investment advisors have been very busy recently, but certainly not because their schemes are about to go bust or need a bail out.
“Many defined benefit (DB) pension schemes have chosen to hedge their exposure to movements in interest rates and inflation – generally implementing these hedges using swaps.
"When interest rates fall, cash from the swap counterparties flow into schemes which either fully or partially offsets the associated rise in their liabilities. However, when interest rates rise – as they have done recently in the aftermath of the Chancellor’s statement – then cash flows the other way as the value of scheme liabilities fall.
“For those schemes that are fully hedged against interest rate movements, recent events would have left their funding position largely unchanged. For schemes that are partially hedged, the rise in interest rates would almost certainly have led to an improvement in their funding positions.
“As interest rates rise, schemes need to honour their side of the swaps trade by passing over cash to their swap counterparties. Most schemes would be well prepared for this event, with pools of cash and gilts ready for such an event. But this means that some schemes would have had to sell gilts to realise the required cash, and this is one of the main reasons why gilt yields rose so sharply. Some schemes would also have had to sell other liquid asset classes, such as high-quality corporate bonds.
“Once the dust settles, I expect most schemes to be in either the same funding position that they were prior to the mini-budget or even in a better one than before.”