- While the global economy is on solid footing, a number of challenges, including supply chain stresses, tight labour force inflation pressures and new COVID variants could put pressure on economic growth, which could hinder returns in equity and fixed income markets.
- With interest rates potentially on the rise, defined benefit (DB) schemes may finally have a chance to make progress against persistent funded status deficits.
- The UK pensions marketplace has seen significant consolidation over the past few years — a trend that we expect to gain momentum in 2022 and beyond.
- While defined contribution (DC) scheme members mostly kept calm during the pandemic, the COVID crisis could have significant consequences for retirement outcomes for years to come.
- The incorporation of the consideration of environmental, social and governance (ESG) factors into the investment decision-making process continues to increase in importance for scheme sponsors, and there are a number of key initiatives that will drive the ESG conversation moving forward.
As we conclude a second year of living with the coronavirus pandemic, it is tempting to focus on the myriad challenges we face in the new year. However, in thinking through the opportunities and challenges scheme sponsors, trustees, consultants and advisors will encounter in 2022, we are inclined to see opportunity. In this piece we discuss key retirement themes for 2022, ranging from the impact of the pandemic on DC scheme members to thorny issues such as consolidation retirement income and sustainable investing. In addition to offering our view on how these issues may play out in 2022, we will provide some practical takeaways for your consideration.
Opportunity: Active management amid challenging market forces
Global markets staged an incredible rally in 2021, fuelled by the reopening of economic activity coupled with governmental stimulus programs and accommodative central bank policies. Many equity indices reached or surpassed all-time highs, with both UK and global equities returning nearly 20% in 2022.i Bond markets were more challenged as yields increased across most fixed income categories, resulting in muted returns for most fixed income indices. Turning our attention to 2022, there are several macroeconomic forces in play: stresses to the supply chain, a tight labour force, new variants of COVID, central bank policies and inflation, which has proven to be more persistent than originally anticipated. These factors threaten to slow global growth in 2022 and beyond.
After nearly a decade of modest levels, inflation now looms as a significant threat to scheme sponsors and members, with consumer price inflation (CPI) rising by 4.2% year over year,ii the highest rate in 10 years. Although some members with DB benefits will have cost-of-living provisions in place, DC schemes are now the primary source of private pensions in the UK,iii which means many workers could face a potential decrease in the buying power of their retirement pots.
In the wake of global markets soaring in 2021, our January 2022 MFS Long Term Capital Market Expectations lays out the case for a ‘lower for longer' environment moving forward. In this context, we believe active management will be key in supporting retirement schemes and members in achieving their return targets.
Opportunity: Implications of rising rates for DB schemes
Positive equity returns coupled with rising interest rates helped many DB scheme sponsors in 2021, with aggregate funded status improving from 95% at the end of December to 105% at the end of November and the aggregate surplus now exceeding £80 billion.
While the aggregate results are encouraging, when we analyse the data, we see stark differences between those schemes that are overfunded, which enjoy an aggregate surplus of £207 billion, versus underfunded schemes, which face a deficit of £126 billion. Schemes could also potentially face higher liabilities as they account for increased inflation; however, those increases can be offset to some degree if rates continue to rise.
Many well-funded schemes have ‘locked in' their funded status through liability-driven investment strategies to the extent possible. However, for underfunded schemes, while further rate increases could help reduce schemes liabilities, we caution sponsors not to ‘hang their hat' on the prospect of rate increases that may not materialise. Rather, we feel the best practice is to lay out a holistic strategy that combines funding policy, benefit design and investment policy to methodically work through deficits in order to meet commitments to members.
This post was funded by MFS