U.K. pension funds had a lot to contend with in 2022, with all the problems that other markets faced in terms of economic impacts on returns, plus the added pressures of September and October’s liquidity crunch.
That being said, U.K. defined benefit plans weren’t the worst performers, with an estimated -20% return, according to consultant XPS Pensions Group. U.K. inflation was 10.5% at year-end, giving a real return of about -31%.
However, put in the context of pension funding and calculating the “comparable return” of liabilities over the year — at -35% — U.K. funds in aggregate ended the year about £400 billion ($488.7 billion) better off, said Simeon Willis, CIO at XPS in London.
The horrors of the fall’s liquidity crisis remain a theme for 2023, with two of his “things to watch” this year relating directly to that period.
One is potential new regulations around the management of LDI, to cover issues including the use of leverage and operational procedures. Based on findings by the House of Lords’ industry and regulators committee, published Feb. 7, “this is potentially far-reaching involving action from regulators, trustees, fund managers and consultants,” he said.
The second thing to watch is the selling of illiquid private markets assets at “distressed prices,” as pension funds continue work to increase the amount of liquid assets in their portfolios to support LDI hedging programs. However, “this has created an opportunity for schemes to buy at a cheap price where they have the ability to hold illiquid assets,” Mr. Willis added.
Pension risk transfer is also on the agenda, with many U.K. pension funds finding themselves in a better funding position than a year ago, said Charles Cowling, chief actuary at Mercer in Manchester, England.
Data from the Pension Protection Fund’s 7800 index show funding ratios at 136.5% as of Dec. 31, vs. 107.7% at the end of 2021. Funding ratios dipped slightly in January 2023, to 134.8%. The PPF is the lifeboat fund for pension plans of insolvent U.K. companies.
However, capacity at the insurers — both human and capital — will be a focus, and moving to buyout is “a huge amount of work — if you fully settle your liabilities, you have got to get your data absolutely agreed between you and an insurance company,” Mr. Cowling added. He said the value of liabilities transacted this year could be anywhere from £50 billion to £100 billion.
Another big question going forward is what happens to inflation and interest rates in the U.K. “If you look at what’s baked in, (market consensus expects) interest rates to peak, at about 4.5%, and projections suggesting inflation will come down to the magic 2% pretty quickly,” added James Brundrett, London-based partner and senior investment consultant at Mercer. “Is that going to happen, and how big a recession are we going to have? In the U.S., consensus is it’s going to be a soft landing — but the U.K. has got its own challenges and inflation is coming down more slowly,” Mr. Brundrett said.
