Bond yields are at all-time lows. Notably, long-date corporate bond yields ended the year as low as they’ve been for at least a decade. My handy source of data doesn’t really go back much further, but I wouldn’t be surprised if they’ve never been this low – ever.
(Source: FT-SE Actuaries indices, Markit iBoxx indices)
This may be great news if you are invested in bonds, but for many defined benefit pension scheme sponsors it is unwelcome news. Unfortunately, pension liabilities on corporate balance sheets should be calculated using a discount rate equal to corporate bond yields. Thus, as yields have fallen, balance sheet liabilities have risen – our friends at Mercer have estimated that overall balance sheet deficits could have doubled over 2014.
Some sponsors may be ambivalent about such balance sheet volatility – taking the longer-term view that what goes up, must come down. But others may be more sensitive, worried about how an apparent weak balance sheet might be perceived by customers, lenders, and possibly even shareholders.
Low corporate bond yields could have other effects. I have a client who pegs commutation factors (the conversion rates used to determine how much pension is reduce by when a member opts for a lump sum on retirement) to corporate bond yields. As yields have fallen, those rates have become steadily more generous – great news for scheme members at retirement, but potentially very expensive for the scheme sponsor. Transfer values are usually linked to bond yields as well, so they too will have become more generous.
Balance sheet volatility may encourage sponsors to try and do a better job of matching assets and liabilities. But trying to match when yields are low means locking in at what feels like precisely the wrong time – unless of course you take the view that in 6 months’ time I’ll still be saying that bond yields are at an all-time low.
John Broome Saunders