Did global stock market meltdown hurt UK pension schemes?

The ‘Black Monday' stock market turmoil on 24 August saw the FTSE 100 index plummet 14% below its peak of almost 7,000 points in February.

Investors across the globe began panic selling stocks, particularly in commodities, amid fears of the much anticipated growth slowdown in China.

While about £96bn was wiped off share values in the UK blue chip index, the Dow fell 1,000 points on opening and the Shanghai Composite experienced total losses of 35% since June.

Hymans Robertson put the total pain for UK defined benefit (DB) schemes at a staggering £30bn surge in aggregate deficits in a day, as equities values and bond yields headed south.

Commentators are divided on whether the event was merely a market correction or an indication of more chaos to come.

But what many agree on is the fact that China is no longer the world's economic growth engine, posing the question of where future investment returns will come from.

Hymans Robertson head of investment consulting John Walbaum says: "I think people have to get real about what they can expect to get from growth assets in the future.

"There was a comment recently from one of the Bank of England monetary policy committee saying the new normal for interest rates might be 2.5-3%. That may or may not be correct. But it's certainly nowhere near the 4.5-5% that many people are still hoping for.

"And then if they're hoping for equities to generate 3% above that perhaps they're being over-optimistic and need to get real about the returns they can expect. If you're trying to fund a pension scheme and growth is not coming through the assets, where is it going to come from?"

JP Morgan Asset Management (JPMAM) managing director for global pension solutions Rupert Brindley is upbeat about the source of future growth. He points out that reductions in commodity and oil prices will subdue inflation, putting more money in the pockets of US and European consumers.

He says: "There's no point crying over spilt milk. But look at what a shock like that is saying about the change in global demand and orient your portfolio to be a beneficiary of that. We've got cheaper US stocks, cheaper European stocks, and cheaper Japanese stocks, than previously."

Aon Hewitt senior partner John Belgrove adds: "Pension schemes are long-term vehicles and trustees set investment policies designed to cope with a range of market conditions.

"Those that have de-risked and diversified appropriate to their individual objectives will feel the most comfortable at this time. Strategies that are equity heavy will be experiencing the greatest mark to market funding strain."

Experts agree that UK schemes should be largely unscathed by the market shock. After all, most defined benefit (DB) schemes have a long time horizon for paying benefits.

Barnett Waddingham partner Matt Tickle says: "It's an issue for those schemes that are quite mature and paying out quite significant amounts each year. But then they shouldn't really be in equities in the first place anyway."

Where it might have an immediate impact is on upcoming accounting valuations. But Tickle adds: "That does then potentially feed into being a real number and a real factor. But again schemes have gone to some extent towards trying to mitigate that where it is an issue."

The recent volatility will have had little impact on schemes that are well hedged against interest rate movements. But the price of hedging will have increased due to the rally in bond markets and because plans to raise rates have been postponed.

The DC perspective

The effects of the market shock are negligible for young savers in defined contribution (DC) schemes. They have plenty of time to regain any losses.

Aon Hewitt investment principal Jo Sharples says: "There's an argument that says those future contributions will benefit from slightly better returns going forward and actually might be better off because of it. They are certainly not worse off because it's a short-term market fall."

But the danger trustees need to be aware of is the potential for the event to encourage young savers to cut their contributions or even axe their pensions altogether. "They may look at their statements and panic," Sharples adds.

DC members nearing retirement should have been largely de-risked out of equities. But there will be consequences for those who did have significant allocations and they may need to retire later or ramp up their contributions to recover from the market fall.

Sharples says: "If you're five years from retirement and you've still got everything in equities then that's quite a big drop and you've only got five years left. So I think it's those people that will be potentially most impacted."