The real Father Ted house... and real yields
Are Father Ted and low interest rates both for real?
My husband, a vicar (‘Father Ted’), and I have just celebrated our wedding anniversary by escaping the chaos of my ‘home’ (the vicarage) for a weekend away.
In addition to the happy couple that we are, the vicarage is usually filled with the chaos of two chaps living in the attic considering if they want to be priests, one lodger (to help pay the bills), one retired priest and our collection of three cats. While you might think that this would always ensure a light was on in the house, the busy nature of everyone who lives there means we also have a timer light switch to ensure burglars are scared away.
Despite this, returning home recently I discovered an empty house with no lights on but the sound of Mozart floating down the stairs from an abandoned radio! Everything was fine in the end, but it made me draw parallels between my abandoned home and some pension schemes that continue on with unchanging investment strategies despite evolving market conditions.
Governance is notoriously difficult, and for a group of trustees who typically meet on a quarterly basis, adapting to ever-changing conditions is a significant challenge. Last week, for example, implied long-term interest rates rose on the back of strong economic data and we reached the ‘oft sought-after’ 2% yield on 30-year UK government bonds. Many schemes consider this level to be their target point to increase interest rate hedging, which becomes cheaper to implement as long-term interest rates rise. However, my phone hasn't been ringing from trustees asking us to do so.
Nonetheless, I suspect that many pension schemes have less to be concerned about than my abandoned home. This is because unlike the vicarage left in the dark, many trustee boards have put in place governance frameworks (like my timer switch) to ensure that their portfolios can adapt to whatever happens, whenever it happens.
A typical set-up often includes triggers that are monitored by the portfolio manager with trustees’ pre-specified actions for when these are reached. Many schemes use time-based triggers (e.g. every month, every quarter) to increase their exposure gradually to interest rates.
These triggers can often work well in combination with either funding level-based triggers (e.g. when we reach 80% funded) or market level-based triggers (e.g. 30-year UK government bond yields reach 2%) to accelerate the hedging in positive market conditions, effectively capturing potential opportunities before they disappear. So just like me and the abandoned vicarage, I hope this is food for thought for those pension schemes that might consider ensuring they're not left in the dark but have suitable systems in place for some extra peace of mind!