ZURICH / LAUSANNE / GENEVA, July 14, 2022 – The rise of discount rates throughout 2022 has led to pension fund liabilities under company international accounting standards falling by over 20% since the beginning of the year, to their lowest levels in 9 years. Pension fund assets have also decreased although to a lesser extent. This strengthened the WTW’s Pension Index by a further 2.5% in Q2. The illustrative funded ratio index (i.e. ratio of pension assets to pension liabilities), as shown by WTW’s Pension Index per 30 June 2022 was at 129.7%, up from 127.2% at 31 March 2022.
Bond yields underlying the discount rate continued to increase sharply for the second quarter running, leading to a further reduction in liabilities since year-end of more than 10%. Corporate bond yields increased by around 90 basis points over the quarter, the same increase that occurred during Q1. Despite assets decreasing by 8.5% for the quarter, company balance sheets were still able to see a positive impact thanks to the decreased liabilities. “As discount rates fell steadily but surely over the last 5-10 years, company pension balance sheets were often hit by liabilities rising faster than asset rises could keep pace. There has been a dramatic U-turn in that trend at least over the first half of this year,” comments Adam Casey, Head of Corporate Retirement Consulting at WTW in Zurich.
As discount rates fell steadily but surely over the last 5-10 years, company pension balance sheets were often hit by liabilities rising faster than asset rises could keep pace.”Adam Casey | Head of Corporate Retirement Consulting, Switzerland
When bond yields rise, the value of bonds held decrease and vice versa. To the extent pension funds hold bonds of a similar duration to their liabilities, this provides a natural hedge (or asset-liability match). During the period of low bond yields many pension funds chose to reduce their exposure to longer term bonds in favour of short-term bonds, property and alternatives. They presumably did this in order to have reduced asset losses when bond yields eventually rose and bond values decreased.
“It seems like many pension funds invested with the expectation of bond yields increasing again. Their investment decision to move away from longer term bonds has now finally come to fruition but was it worth it and more importantly how should they invest their portfolios in the new market environment?” Adam Casey explains.
The durability of Pension Funds’ portfolios in terms of their resistance to crises continues to be severely challenged. Global markets continue to suffer from shock losses, driven by the Ukraine-war and the build-up of problems for economic growth in a higher inflation environment. The return achieved by a typical Swiss pension fund was -8.5% in the second quarter of 2022, giving a year-to-date return of -13.3%, as represented by Pictet’s 2005 BVG-40 Plus Index. However, most Swiss pension funds reacted calmly to this development so far.
For several months now, after 15 years of expansive monetary policy bringing real rates below 0%, the inflation rate has been climbing upward, even if, compared to the U.S. and Europe with up to 8%, Switzerland is holding up much lower at 3.4% in June thanks to the strength of the Swiss franc. Rising inflation is associated with a loss of purchasing power as well as losses on many investments. Hence the effects of inflation should be a key focus of pension fund’s review of their investment strategy with respect to its crisis-resistance.
Higher interest rates combined with recession fears led to losses in bonds and equities at the same time.”Alexandra Tischendorf | Head of Investment, Switzerland
That review may be somewhat complex as Alexandra Tischendorf, Head of Investment at WTW in Zurich, explains: “The effect inflation might have on real assets is somewhat tricky, as depending on the level of inflation real assets might rise in price or fall and inflation protection is only limited, as rising values are also accompanied by significantly higher volatility. The current turmoil reflects this, as higher interest rates combined with recession fears led to losses in bonds and equities at the same time.”
Despite the challenges of the current environment, it is important that Pension Fund Boards do not lose sight of their long-term investment horizon and goals. "Pension Fund Boards must continue to focus on the long-term, sustainable orientation of the investment strategy. This includes parameters such as diversification of risk premiums, consideration of sustainable investment principles and enhanced risk management and governance,” Alexandra Tischendorf advises.
Swiss Pension Finance Watch reviews quarterly how capital market performance affects pension plan financing in Switzerland. The study is part of the Global Pension Finance Watch from WTW which includes results back to 2000 for major retirement markets worldwide. The results are published quarterly with a focus on linked asset/liability results. It covers pension plans in Brazil, Canada, the Euro-zone, Japan, Switzerland, the U.K. and the U.S.
The impact of capital markets on these pension plans is two-fold:
WTW’s model defines a benchmark pension plan that is intended to be representative of the pension liabilities and plan assets (including asset mix) that are typically found in each global market. The impact of movements in capital markets on assets and liabilities is combined to produce a Pension Index which reflects the movement in the funding level of the benchmark pension plan.