Archive for June 2020

Simon Cohen

It had all started to look so good in the investment markets.  Having fallen significantly, most markets had rallied strongly with equities in the US actually up for the year, having been 20-25% lower (during March).  In fact, the NASDAQ briefly hit an all-time high.  Long-dated gilt yields also rose slightly, hitting the heady heights of 0.8% at one point, still very low but not at the levels of 0.3% achieved in March, when market turmoil was at its greatest.

This all seemed a bit strange to me and many economists.  We are about to enter potentially the biggest recession that we have ever suffered, yet some markets are at all-time highs.  In fact, the day that it was announced that the UK had contracted by a massive 20%, the FTSE rose by over 1%.  The markets seemed to be pricing in a “V” shaped recovery, and I, like many others, am not convinced.

After a sharp fall on 11 June, the NASDAQ is now back at an all-time high.  UK long-term gilt yields remain very volatile and are currently sitting at around 0.7%.

What does all this mean for pension schemes?

During the market turmoil, many pension schemes had seen their funding levels hit by the “double whammy” of falling growth markets and falling interest rates (leading to higher liabilities).  Their funding levels had on average fallen by about 5-10%. 

With the market recovery, they will have seen funding levels improve.  They are still unlikely to be back to where they were.  For two reasons, firstly if a funding level falls by 10%, the level needs to rise by at least 11% to get back to where it was.  Also, albeit markets had rallied, many markets were not back to the levels where they used to be. 

What should pension schemes be doing?  

My view is that pension schemes should be taking the opportunity to de-risk their investment strategies if they can afford to do so, whilst the markets are still  positive.  They should try to do this quickly.  However, in implementing this they need to be careful.  They should spread their trades across a few tranches as market volatility has picked up a little and they wouldn’t want to trade on the “wrong day”.  This means there is a fine balancing act between getting the trades implemented quickly, but also avoiding dealing on the wrong day by spreading the trades.  Even if pension schemes are not in a position to de-risk, I think trustees should be keeping a close eye on the markets and be ready for a stormier time in future.

John Wilson

Pension scheme auditors and trustees face are facing additional scheme reporting challenges as a result of COVID-19. This has led to the publication of a new guide, applying to DB and DC pension schemes, from a joint working party.

Representatives from ICAS, ICAEW and PRAG have produced ‘Pension scheme reports and financial statements, and related matters in the context of the COVID-19 pandemic’. The guide can be downloaded at,-financial-statements-and-audit-_FINAL.pdf.

The joint working party makes it clear from the outset of the guide that there are no changes to the requirements for preparing and auditing pension scheme financial statements. Annual reports and accounts for pension schemes still need to be produced within seven months of the scheme year end.

However, as ‘business as usual has been disrupted’ by the pandemic, they recommend that trustees and auditors check The Pension Regulator’s website regularly for any updates relating to pension scheme annual reports.

The guide also recommends that ‘in view of the COVID-19 pandemic, trustees need to consider whether the going concern basis remains appropriate’. And trustees should make allowances for additional complexities when producing reports, financial statements, and chair statements.

Auditors will need to consider the impact of COVID-19 on all aspects of the audit and discuss these with trustees, where appropriate. In particular, when compiling the statement about contributions, auditors will need to determine to what extent, if any, contributions to the scheme have been affected by:

  • the reduction or suspension of deficit recovery contributions or future contributions;
  • changes in pensionable earnings, and
  • the furloughing of employees.

Overall, the joint working party has produced useful guidance for trustees to take into account when discussing scheme reporting during COVID-19 with their auditors. Trustees should also consider what additional messages they might need to include on member communications, such as annual benefit statements.

James Sweetnam

“All good things must come to an end”, “What goes up, must come down” – a bear market is the stock market’s answer to investors’ dreams of everlasting asset growth. But how long does it take to recover after the market hits rock bottom?

A bear market is defined as a peak-to-trough fall in the value of assets (a “drawdown”) of 20% or more. Since the end of WWII there have been eleven bear markets recorded on S&P 500, the US stock market, on average occurring after every 5.3 years of growth.

The 11 years from the lows of the 2008 Global Financial Crisis (GFC) crash, to the all-time highs before the COVID-19 pandemic hit, was the longest period of continuous stock market growth since WWII.

So, if we have a long-term investment time horizon, it is safe to assume that there will be a few significant setbacks along the way. To determine the extent to which a 20%+ drawdown will stunt the growth of a pool of equity investments, we look below at the statistics on bear market duration, severity and recovery.

Table 1: Market cycles – a summary of market cycles since WWII ranked on size, in terms of bear market, followed by a recovery, followed by a further period of growth before the next bear market.

  • Graph 1 above shows the relationship between the bear market duration (the amount of time the market was in a downtrend) and the recovery period (time to get back to pre-bear market levels). The  amount of time a market is trending down and the amount of time to recover do not seem to be strongly correlated.
  • Graph 2 shows there is a similar lack of relationship between the length of a bear market and its severity. A long period of falling assets does not necessarily mean they fell by a large amount, and vice versa. In other words, historically, the bear market duration has not had a significant effect on the other characteristics of a bear market.
  • However, Graph 3, plotting the relationship between the severity of a bear market and the recovery time, shows a more distinct trend; the size of a bear market is correlated to the amount of time to recovery. Even when you look pre-WWII at the stock market crash of 1929, the precursor to the great depression, the trend holds. The 83% decline in the S&P 500 took 151 months (nearly 13 years) to recover from.

So, when looking at historic bear market recovery periods, a pretty good indicator has been the size of the mountain to climb to get back to previous levels. A “snap recovery” is possible for minor drawdowns, the 3-month recovery from a 27% drawdown in 1980 is the best evidence of this. However, larger bear markets are associated with deeper problems in financial markets, and can take significantly longer from which to recover.


In an ideal world, an investor would enter the market at the start of a bull market, remain invested until just before the start of a bear market, disinvest into bonds or cash until all the damage has been done and then reinvest. This is of course impossible to do. However, many investors often do the opposite – when the markets have been going up for a while they invest, and when markets fall, they lose confidence and disinvest, missing out on gains and locking in losses.

Trustees should keep this in mind in times such as these, where the S&P 500 fell 34% from 19 February to 23 March 2020. History would suggest that this level of losses takes between one and two years to claw back. This certainly feels like a long time to go without making progress towards goals, however, panicking and disinvesting now would mean missing out on the recovery and extending the amount of time until goals are reached.

As the conditions that caused markets to decline start to stabilise, so will investor confidence. Investors will stop seeing the stock market as a risk not worth taking, and start to see the value that presents itself after a significant market correction. Confidence will slowly creep back as the recovery gets going and, after a while, those that withdrew will start to return. Positive sentiment will snowball and the market will revert back to reasonable levels. Inevitably, when positive sentiment eventually reaches excess levels, the market will correct itself once again and hence the market cycle continues.

Even accounting for the inevitable bear markets, investing assets in the stock market is still a good way to protect against inflation and grow assets over time. While remaining invested is easy as the gains come in, doing so when they are not is hard, but just as important.   

Angela Burns

An employer perspective

Many employers will be in the process of consulting on 31 March 2020 actuarial valuations.

As part of the valuation process the Trustees must consult with the employer.  The Trustees will engage with the employer in relation to the assumptions to use in the valuation, and on the contributions to be agreed as part of any Recovery Plan.

The current climate is likely to impact on these discussions in a number of areas:

  • The funding position given market conditions as at 31 March 2020;
  • The covenant of the Employer and short-term cashflow.

Funding position

Funding positions as at 31 March 2020 are likely to be variable.

Interest rates have fallen by around 1% p.a. since 31 March 2017 which will increase liabilities by around 20% depending on the maturity of the scheme.  Inflation has also fallen by around 0.6% p.a. which will reduce liabilities, all other things being equal.  The impact will depend on the level of inflation linked benefits in the scheme.  Considering both effects, schemes are likely to see increased liabilities, with schemes with fixed benefits impacted more.

The deficit position will also be impacted by how scheme assets have performed.  The position will be highly dependent on the individual investments held.  Growth assets may be broadly neutral – performing well until early 2020 then falling sharply due to Covid-19.  Bonds will have performed well – any schemes with hedging in place will have seen the value of this in recent months.

Schemes may have also seen positive experience since the previous valuation.  Inflation may well have been lower than assumed over the period.  The impact of member events, such as taking a Pension Commencement Lump Sum on retirement, will have more of an impact due to the low interest rate environment.

Overall, on a like for like basis with the previous valuation, deficits are likely to have increased for schemes with fixed benefits and no hedging in place, and decreased for schemes with inflation linked benefits and high levels of hedging.

When considering assumption setting at 31 March 2020, we would expect to see updated mortality assumptions based on the most recently available information.  We would also encourage consideration of future expected returns and how these may have changed given the current environment – for example has the equity risk premium increased and if so should a like-for-like ‘gilts plus’ basis have a higher outperformance assumption?  It is important that prudence is not compounded.  We would also look for recovery plans to allow for best-estimate returns on scheme assets where this is appropriate.

Covenant/Cash Constraints

The Pensions Regulator generally expects to see a similar level of contributions agreed as in previous years, with good reasoning if contributions have to reduce.  The best support for a pension scheme is a strong employer.  Employers can negotiate on the level and timing of contributions payable and, as a result of Covid-19, can request a deferral of contributions to ensure the ongoing viability of the business.

Trustees are likely to request cashflow forecasts and management accounts to show the need for any reduction/deferral.  Employers should be aware that less contributions now means more contributions later.

What should employers consider when agreeing valuations?

It is important that employers take their own professional advice, in particular in relation to setting the assumptions.  There is a range of acceptable assumptions and ensuring these are set at the appropriate level should help with affordability.

It is important that as well as agreeing the valuation, employers consider a long-term view – what is the ultimate goal and what is the plan to get there? Advisers can help with strategy and journey plans and give employers some direction and control over the pension scheme.

There is 15 months to complete the valuation process.  We would expect that the majority of valuations are completed well within this window.

Brendan McLean

Humans have evolved with the ability to make quick decisions based on limited stimuli or information. We are often required to act immediately to a potential threat – for example, we press the brakes of a car almost concurrently as an obstacle appears suddenly in the way. Whilst this quick decision-making has always been vital for our survival, the psychology behind it can lead humans to make poor decisions, particularly when the stimuli present is not in the form of a huge bear, an obstacle in front of our car, or other such clear danger. Investment data is a cacophony of complex information, yet we are naturally inclined to respond to this stimulus in a similar way. 

Traditional finance theory assumes investors are rational and make optimal decisions 100% of the time. This is clearly not the case. More recently, the field of Behavioural Finance has attempted to understand how investors really make decisions both individually and collectively and how their inherit biases affect their decision making. 

COVID-19 has caused extreme market volatility, exacerbated by behaviour biases; fear, the media, and even working at home will have impacted investors thinking. Such behaviour biases include: 

  • Availability bias: investors make decisions based on the information that comes most easily to their mind, such as the news. 
  • Representativeness bias: investors classify new information based on past experiences such as the market declines during the global financial crisis in 2008/09. 
  • Herding bias: many investors make the same decisions at the same time which causes contagion of thought, as well as rapid declines in asset values which cause them to become over/undervalued. 

Just as individual investors are susceptible to such behaviour biases, so are professional investment fund managers. One of the ways investors can be confident that their fund managers are able to overcome their biases is by having a robust investment process in place. A manager’s investment process provides an instruction manual on how to manage their fund. Often it can be difficult for investors to determine if managers are following their investment process, however, performance beyond expectations can be an indication they are not following their process and further investigation is required. If a manager has not followed their set process it makes it hard to predict what the future return and risk profile will be. 

Trustees will need to work with their advisors to ensure their funds remain suitable in light of such recent extreme market events, and that fund managers are working by the ways of their investment processes, not these psychological traps. 

Page 1 of 11