UK - Pension funds will hold more bonds than equities by 2010 and must ensure they manage the associated risks adequately, the Actuarial Profession warns.
The Profession’s finance and investment conference in Brussels heard that the current “huge demand” for bonds would continue until the end of the decade.
Keynote speaker, Watson Wyatt senior consultant Hemal Popat (pictured) – co-author of the paper Institutional Demand for Investment Classes: Is there a supply problem? – said that by the end of the decade, UK equities would represent just 20% of funds’ total holdings, with a similar amount invested overseas.
The paper predicts funds will purchase a further £120bn of bonds, with the demand from schemes expected to exceed £200bn in some scenarios by 2010.
Popat warned that the shortage of inflation-linked bonds could be a major problem, particularly for funds linking pension payments to the Retail Price Index.
He said: “While the government is proposing to begin issuing large volumes of index-linked gilts, there is a huge opportunity for companies to tap into the demand by issuing inflation-linked corporate bonds.”
He expected the corporate market to grow “explosively” from its current £9bn to more than £40bn by the end of the decade, and urged pension funds to monitor their credit risks carefully.
Popat claimed it was a “sad fact” that pension funds lacked the sophistication of banks and insurance companies in monitoring their credit and currency exposures, relying instead on diversification.
He said: “Pension funds need to understand how the risks of these products interact with the risks the fund is already running.
“On a more positive note, these new developments will be very helpful for well-advised pension funds as they will increase the supply of suitable inflation-linked assets to allow them to match their members’ inflation-linked pensions at lower cost than at present.”
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