Following the Bank of England’s (10 May) widely anticipated decision to keep interest rates at the current level of 0.5%, Robert Palmer, partner at independent financial services consultancy Quantum Advisory, explains what options there are for UK pension schemes as prevailing market conditions continue to be a massive challenge for all key stakeholders.
Robert says: “Anemic first quarter growth has led to The Bank of England kicking the can down the road by voting 7-2 to keep the base rate as is. A few months ago, the consensus was that there would be a rate rise with the market already pricing one in! The timing of future rate rises is also increasingly uncertain and it feels like a good time to revisit what impact this is having on defined benefit pension schemes. For example, low interest rates mean Cash Equivalent Transfer Values (CETV) – the transfer value from a final salary scheme – remain high. Great news for the recipient, but not so good for the scheme that must fund it. Further large pension payments coupled with material CETVs, will result in schemes becoming cashflow negative. An investment solution is required to ensure suitable liquid assets are available when required to meet these benefit payments.
“Cashflow Driven Investment (CDI) presents a viable solution for those waiting for interest rates to rise before increasing their exposure to ‘protection assets’. A diversified portfolio of growth assets may offer a more attractive return potential but can carry too much risk over such short periods. CDI mitigates this short-term risk, at the cost of more modest returns.
“A relatively new breed of credit based pooled funds could offer the best of both worlds. These provide a degree of extra return above cash plus predictable cash flows that mirror the short-term benefit outgo of a typical UK pension scheme. The cash flows are sculpted from the coupons and redemptions of a combination of gilts, global buy-and-maintain credit and amortising multi-asset credit, plus derivatives to fill any gaps.
“With the increasing uncertainty surrounding future rate rises, I believe that cashflow negative schemes should consider implementing CDI strategies”
Robert Palmer, Partner at Quantum