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BlackRock's Tunningley Comments On PPF 7800 Index Figures

The arrival of snow and the UK’s big freeze is a timely reminder: it can be hard to get things done for those not well prepared. Funding levels of UK pension funds froze in November, with the PPF 7800 Index chilling at 94.7% - exactly the same as the previous month. There was little movement in UK government bond yields over the month, and regional equity market indices had mixed performance; the UK, European and Emerging market indices all closed the month lower than they started, though world equities were modestly up overall.

Last week the PPF published its annual Purple Book, a snapshot of the health of UK schemes that captures important trends in investment or activity. This year, the key trends of previous years continued: on aggregate, schemes are maturing and are de-risking. Schemes continue shifting their asset allocations away from equities to government bonds and alternatives. This echoes the trends we are seeing and advocating. Maturing schemes increasingly need to adapt their investment strategy to place greater focus on de-risking, and often have an objective to make the portfolio more ‘cashflow aware’ as they face periods of cashflow negativity. In short; they need to be prepared for the challenges ahead.

For underfunded mature schemes; the challenge is particularly stark – how should they juggle near-term cashflow needs – required to pay today’s pensioners now - with long-term return objectives – required to improve the security of the benefits of future pensioners?

In our view, the answer is a holistic approach to portfolio construction – a framework that considers cash outflows, income, risk and return in combination, rather than prioritizing one of those objectives. We think combining traditional liability hedging assets with well-chosen corporate credit, private assets, and a diversified growth portfolio can achieve this. Underfunded schemes with excessive or insufficient allocations to any of these asset groups can suffer in adverse scenarios. In particular, schemes should beware of investment strategies that prioritise cashflow generation but compromise risk or return objectives – i.e. ‘cashflow for the sake of cashflow’. Locking into poor investments, whether or not they provide cashflow, runs the risk of schemes seeing their deficits snowballing. A balanced approach is better for thawing the sizeable deficits that schemes are facing this winter and beyond.