Pension funds reeling from ‘financial vandalism’ of falling yields

A once unthinkable collapse in global bond yields is forcing pension funds to buy bonds offering negative yields, jeopardizing the financial security of future retirees.

U.S. institutions managing trillions of dollars in retirement savings — including California’s public employee retirement system, Sacramento — $376.3 billion — cut return expectations. Japan’s 159.2 trillion yen ($1.47 trillion) Japanese government pension investment fund, Tokyo, the world’s largest pension fund, has warned that fund managers risk losses in all asset classes. In Europe, pension funds may be forced to cut benefits in part because of falling rates.

Investors were already taking on more credit risk to offset lower earnings elsewhere, with some seeking less liquid markets like private debt. Today, negative yields of more than a quarter on investment grade bonds – with further monetary easing to come – increase the urgency for portfolio managers to find new sources of yield.

“The real madness is that pension funds are forced to invest in assets (that) will be guaranteed to lose, as in the case of long-term inflation-linked gilts at real returns of -3%,” said Mark Dowding, chief investment officer. at BlueBay Asset Management, which has pension fund mandates. “This is financial vandalism and the government and central banks need to realize that.”

Pension funds invest in a variety of assets, but most, including defined benefit plans, use low-risk assets such as government bonds as their benchmark discount rate. While that means they have benefited from the rise in fixed income, falling yields have also pushed up future liabilities, in turn threatening their ability to meet future obligations.

CalPERS Chief Investment Officer Yu Ben Meng said earlier this year that the expected annualized return over the next 10 years would be 6.1%, down from a previous target of 7%. Scott Minerd, CIO of Guggenheim Partners, warns that the Federal Reserve’s policy easing is contributing to a likely bubble in government bonds and that very narrow credit spreads have greater potential for widening.
Ten-year yields are negative in higher-rated European government bond markets, while Germany’s entire curve has fallen below zero. Similar rates are also below zero in Japan, while they recently hit record highs in Australia and New Zealand. In the United States, 30-year Treasury yields hit an all-time low of 1.91% this month.