Britain’s pension industry could find itself in difficulty because its key asset holdings — government bonds — have negative yields.
Pension funds, the money that is invested to make returns for workers and are then given out once they retire, are among the largest holders of UK government debt.
They invest this way because the funds are more risk adverse and government bonds are seen as safe and steady, unlike asset classes such as equities.
So, if government bonds are not producing returns, this means it is increasingly difficult for institutions to give workers agreed pension payouts once they retire.
In other words, there is a real chance that some of the country’s largest companies will struggle to pay pensions, if Britain’s economic situation stays the same as it is now for the next couple of years.
Ever since Britain voted to leave the European Union — Brexit — on June 23, Britain’s markets have been on a rollercoaster ride.
The pound has sunk to 30-year lows, UK government bonds (gilts) traded in negative territory on Wednesday, and Bank of England has cut interest rates to a record low of 0.25%. This is after keeping rates at 0.5% since March 2009. Low interest rates are great for people in debt — it keeps the cost of borrowing cheap.
The rate cut, as well as the BOE’s £70 billion asset purchase programme, is part of the central bank’s stimulus programme. Low rates are meant to therefore stimulate the economy as it allows people to keep paying their debts, including mortgages, as well as keep them spending.
But for savers, this is terrible. This is because it means you make very little on fixed income investments, such as bonds. The stimulus plan also pushes bond yields lower.
British bond yields are now traversing record lows, with the benchmark 10-year gilt yielding just 0.523% as of 6:25 a.m. BST after falling in negative territory the previous day.
Here’s the chart:
Even if bonds yielded some form of return, as low as this, it does not mean that it is entirely good news for pension funds.
On Wednesday, one of Britain’s major employers Royal Mail wrote to staff to tell them that it may have to close its pension scheme because financial market conditions has made it “unaffordable” beyond 2018, according to the Financial Times.
This is devastating news for the country overall because Royal Mail employs 140,000 people and can be seen as a litmus test for other major employers in the country. And even if it does pay out pensions, it could be significantly less than what the pensioners banked on.
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