Markets have been extremely volatile in recent weeks primarily due to Covid-19. Many countries are in lock down and a sharp eurozone recession could be on the horizon.
Many employers will be approaching their year-end with accounting figures to be produced at 31 March 2020 and will be worried about what recent market movements can mean for accounting figures. Markets are fluctuating daily, but current conditions could actually see an improvement in the accounting position for many schemes.
The table below sets out how various economic indicators have changed since 31 March 2019
|31 March 2019||18 March 2020|
|iBoxx >15 Corporate Bond Index||2.35% p.a.||3.00% p.a.|
|Bank of England 20-year Implied inflation||3.65% p.a.||3.00% p.a.*|
|Bank of England 20-year nominal spot yield||1.60% p.a.||1.30% p.a.*|
|FTSE All Share Total Return Index||7235.16||5213.67|
*estimate based on gilt yield movements
Gilts yields have fallen since 31 March 2019 from 1.60% p.a. to around 1.30% p.a. (although the figure was as low as 0.5% p.a. only a week or so ago).
However, credit spreads have increased dramatically, and the result is that corporate bond yields (on which accounting valuations are based) have increased by around 0.65% p.a. (and have effectively doubled over the last week or so)
Inflation has decreased by 0.65% p.a. and has been much more stable than the gilt or corporate bond yields.
Overall, for schemes with inflation linked benefits, accounting liabilities as at 31 March 2020 (if market conditions are unchanged from now) will have reduced, all other things being equal.
The overall funding position will also depend on how assets have performed. Schemes with high equity exposure will have seen a significant drop in asset values with the FTSE All Share Total Return Index falling by almost 30%.
Schemes with Liability Driven Investment (LDI) are likely to see an increase in asset values due to the significant falls in gilt yields (albeit these returns are very volatile). Well hedged schemes (against gilt yield movements) may therefore see a material improvement in their position.
The table below sets out our broad estimated position for a sample scheme assuming different investment strategies.
31 March 2019 Accounting Position
Liabilities: £35m (50% linked to inflation movements)
Investment strategy 1: 30% LDI, 20% Corporate Bonds, 25% equity, 25% diversified growth
Investment strategy 2: 75% equity, 15% corporate bonds, 15% gilts
Estimated position at 16 March 2020
|31 March 2019 Actual||31 March 2020 Estimated Investment Strategy 1||31 March 2020 Estimated Investment Strategy 2|
As you can see from the table, we expect that schemes with a high proportion of hedging and a more conservative investment strategy will have an improved accounting position based on current market conditions. Schemes with a high-risk strategy and lower proportion of hedging may still be in a similar position to last year despite huge falls in asset values.
Please speak to your usual Spence contact if you have any queries or would like some preliminary figures in advance of your year end.