WTW Swiss Pension Finance Watch – Q3/2022
ZURICH / LAUSANNE / GENEVA, October 13, 2022 – WTW’s Pension Index fell by 4.4% in Q3 due to a further depreciation in asset values.
During the first half of 2022 the sharp and steady rise in discount rates offset the decline in asset values and companys’ pension balance sheets continued to improve. During Q3, corporate bond yields, which dictate discount rates, were very volatile but only ended marginally higher than at the end of the previous quarter. Overall, pension fund liabilities remained relatively stable compared to the end of Q2. Pension fund liabilities under company international accounting standards continue to hover at around 20% lower than at the beginning of the year and are close to their lowest levels in 9 years. Pension fund assets decreased by a further 3.3% during Q3, driving a reduction in WTW’s Pension Index by 4.4%. The illustrative funded ratio index (i.e. ratio of pension assets to pension liabilities) was at 125.3%, as shown by WTW’s Pension Index per 30 September 2022 and down from 129.7% on 30 June 2022.
For the first time in more than 10 years, the bond yields that drive discount rates have inverted at durations that are important for pension funds. In these conditions, this means for pension plans with durations longer than 10 years, the longer the duration of the plan, the lower the discount rate (perhaps by as much as 5 to 10 basis points). Normally it would be the opposite because under “normal” circumstances, the longer the duration of a bond, the more return a debt holder requires in order to compensate them for interest rate and default risk.
“Despite volatile market conditions, very poor asset returns year to date and the unusual inversion of the corporate bond yield curve, companies can still expect improved net pension balance sheet liabilities compared to the beginning of the year.”
Adam Casey | Head of Corporate Retirement Consulting, Switzerland
“Despite volatile market conditions, very poor asset returns year to date and the unusual inversion of the corporate bond yield curve, companies can still expect improved net pension balance sheet liabilities compared to the beginning of the year. On the other hand, local pension plan funding positions will have deteriorated significantly due to the technical interest rate underlying the local liabilities remaining much more stable,” comments Adam Casey, Head of Corporate Retirement Consulting at WTW in Zurich.
For plans with durations up to 16 years, the discount rate improved during Q3, however the discount rate for plans with longer durations decreased over the quarter.
“Due to the shape of the yield curve, for companies who report their pension balance sheets on a quarterly basis, it is more difficult to estimate roughly whether their liabilities will have increased or decreased over the quarter, as this will depend on the duration of the plan,” Adam Casey explains.
With a yield curve inversion, investors who purchase longer dated bonds are willing to accept lower compensation for their exposure to the borrowing risks than they would receive for exposing themselves to a shorter period-term. As such, a yield curve inversion is usually considered as a sign that the market is rather pessimistic about the economic prospects for the near future.
Pension funds suffered another negative quarter in Q3, although the brief respite in July somewhat offset the particularly poor September. Typical Swiss pension fund assets slumped by around 3% in the quarter, and the year-to-date return is now commonly around -13%.
Inflation rates continued to rise sharply, so that the central banks had to react strongly with interest rate hikes. For the USA, it is assumed that the peak of inflation has already been reached and will now level off. For Europe, the peak is expected in Q4 or Q1 2023 at the latest. The inflation rate in Switzerland was with 3.5% in August still lower than in their foreign neighbour countries. “Given the expectation that interest rates are peaking in the mid to short term, investing in bonds versus equities are becoming attractive again”, says Alexandra Tischendorf, Head of Investment at WTW.
Real rates are rising even if still in the negative area. Within the bonds segment there seems to be opportunities in the investment grade bonds spectrum, as credit valuations dropped from their peaks and high yield default rates are rising.
Despite the challenges of the current environment, it is important that Pension Fund Boards do not lose sight of their long-term investment horizon and goals.
“Pension Fund Boards must continue to focus on the long-term, sustainable orientation of the investment strategy.”
Alexandra Tischendor | Head of Investment, Switzerland
"Pension Fund Boards must continue to focus on the long-term, sustainable orientation of the investment strategy. This includes parameters such as diversification of risk premiums, consideration of sustainable investment principles and enhanced risk management and governance,” Alexandra Tischendorf advises.
Swiss Pension Finance Watch reviews quarterly how capital market performance affects pension plan financing in Switzerland. The study is part of the Global Pension Finance Watch from WTW which includes results back to 2000 for major retirement markets worldwide. The results are published quarterly with a focus on linked asset/liability results. It covers pension plans in Brazil, Canada, the Euro-zone, Japan, Switzerland, the U.K. and the U.S.
The impact of capital markets on these pension plans is two-fold:
WTW’s model defines a benchmark pension plan that is intended to be representative of the pension liabilities and plan assets (including asset mix) that are typically found in each global market. The impact of movements in capital markets on assets and liabilities is combined to produce a Pension Index which reflects the movement in the funding level of the benchmark pension plan.
