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The Actuary The magazine of the Institute & Faculty of Actuaries
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Liabilities up 6% as flight from equity pushes down bond yields

Cardano client manager Phil Page believes this rise in liability values - of 6% - 6.5% in the last five weeks for the average scheme - has often slipped under the radar.

Page pointed out that this was a long-term trend caused by a dramatic fall in yields on index-linked bonds.

"The yield above inflation on a 15-year duration index-linked gilt now is about 0.4% but if you went back to July 2010, it was three times higher at about 1.2%," he said.

He added that this trend was being accelerated - the yield fell from 0.6% to 0.4% in the last two months - by investors fleeing equities and looking for safer assets with inflation protection.

"Under the current stress, they're buying index-linked gilts, that's pushing the yield down and therefore pushing the value of liabilities up and you've got this double whammy," he explained.

On the asset-side, Page described the five weeks from the beginning of July as a "bloodbath" with corporate bonds down and equity values plummeting.

In July the MSCI World Index was down about 4% and the FTSE All Share index fell by 2%, and in the first week of August these indices dropped a further 8% and 10% respectively.

"So over the last 5 weeks, if a scheme was 100% funded it will now probably be less than 95% funded, and in the worst cases it will be around 90%," explained Page.

He said this was unlikely to correct itself in the short-term - particularly on the liability side as long-term yields on government bonds are likely to remain low.

But he added that this could be hedged with bonds and swaps on the liability side and by diversifying portfolios beyond equities on the asset side.

"The mechanics of the market are fine - you can buy the right instruments to hedge the risk pretty precisely. The question is are you hedging at what is a bad price today, and you should consider that risk in just the same way as you would the risk of investing in equities," he said.