FTSE350 DB schemes face investment puzzle to stay on course for endgame

• COVID-19 has pushed back the endgame timescales of FTSE350 DB schemes significantly, and to get back on track through investment returns alone, schemes would need an average additional return of 1.4% per annum
• The current average expected investment return of the FTSE350 DB schemes is 1.6% per annum above the yield on gilts, but as of 31st July 2020, schemes needed an average investment return of 3.0% per annum above the yield on gilts to maintain the endgame timescales expected in December 2019
• Schemes expecting to buyout within 5 years would need an additional 2.6% per annum in investment returns to maintain the same timescales

FTSE350 companies with a defined benefit (DB) pension scheme need to achieve an additional annual return of 1.4% per annum above current best estimates if they are to maintain the buyout date expected at the start of the year, according to our latest analysis. 

FTSE350 companies with DB schemes have been hard hit by the Covid-19 pandemic, with the combination of a fall in equity markets and a further decrease in bond yields resulting in a deterioration in scheme funding levels. On average, Covid-19 had pushed back the FTSE350 DB endgame by around a year and a half over the six months to the end of June 2020. As a result, many schemes will no longer be on track to reach their endgame within the desired timescales and face an investment return challenge. 

Based on Barnett Waddingham’s asset model, the current average expected investment return of the FTSE350 DB schemes is 1.6% per annum above the yield on government bonds. But due to Covid-19 putting substantial pressure on their funding levels, as of July 31st DB schemes will need to achieve an average investment return of 3.0% per annum above the yield on government bonds to reach the same endgame timeframes expected in December 2019.

This means that the FTSE350 DB schemes would need to achieve an additional annual return of 1.4% per annum above current best estimates to reach endgame in line with expectations at the start of the year.

DB schemes will have been impacted differently depending on how far away they already were from their endgames. Schemes aiming to buyout within over a longer timeframe have more of a chance to get back on track through investment returns alone.  For example, schemes aiming to buyout in over 15 years will only need an additional 0.1% per annum in investment returns to get back on track.

On the other end of the spectrum, DB schemes that were looking to buyout within 5 years face a bigger challenge to recover losses in a limited time period. If they want to do so through additional investment returns, they would need an additional 2.6% per annum; a much more difficult achievement. For schemes expecting to buyout within 10 years, they’d need an additional 0.8% in investment returns to maintain this target date. 

Despite this, FTSE350 DB schemes that were already further along their endgame journey plans with de-risked, well-hedged strategies and reasonably short time horizons to buyout were significantly less impacted by the market volatility than those who remain more than 10 years from their endgame and with higher levels of investment risk. 

Simon Taylor, Partner at Barnett Waddingham, said: “The economic impact of the pandemic has affected all DB schemes, with many suffering significant setbacks to their long-term funding plans. When the crisis hit, endgame timescales will have been low on the list of issues for FTSE350 companies, but companies and trustees are now in a position to assess how events have impacted their scheme, and whether they need to adapt existing strategies or create a new plan altogether.

“The recent market volatility provides a clear illustration to companies and trustees of the level of investment risk that they are running. All schemes should be reviewing the movements in funding levels over recent months and consider whether they are truly comfortable with this level of risk given the potential financial implications.   

“Companies and trustees have a number of levers to get their long-term plan back on track, and all options should be actively explored. Unfortunately, the reality for some schemes will be a delay to the DB endgame.  

“More optimistically, putting aside the obvious challenges, recent economic turmoil has created investment opportunities in some pockets of the market. It’s vital for schemes to explore options to refine their investment strategies and take advantage of market volatility where possible.”