UK pension funds leading the charge in the corporate bond resurgence

Business Insights

Latest research reveals that UK pension funds have seen an increasing in funding due to the UK's high interest rates

The resurgence of the UK corporate bond market is being driven by increased demand from pension funds, particularly those in the UK with defined benefit schemes. These pension funds are seeking higher yields and preparing for potential sales to insurers as due to the rise in interest rates, more pension schemes have become fully funded, making buyout deals more viable. To attract buyers, companies are focusing on having the right assets, including sterling-denominated corporate bonds, which are in high demand due to their additional return over gilts, interest rate protection, and familiarity. In light of this optimistic news, Rudy Khaitan, Managing Partner of the UK's leading later-life lending specialist, Senior Capital, argues that by adopting alternative schemes, such as fixed income allocations, pension funds' risks can be reduced by providing a source of long-term income that can decrease the reliance on debt. With the UK falling behind its counterparts on delivering returns through it pensions industry, by pooling both schemes together, private equity funds can mitigate risk with alternative asset allocations, opting for fixed-income allocations such as residential mortgage-backed securities (RMBS).

Khaitan explains that bonds formed from equity release loans could not only diversify the portfolio of pension funds but also offer attractive risk-adjusted yields and more importantly, align any liabilities and regulatory requirements these schemes are subject to. The UK equity release market, having grown by 100% in the last five years, is now seeing record activity as consumers continue to feel the financial impacts of inflationary pressures and rising interest rates. In a period when almost a quarter (23%) of the nation is over the age of 60, according to Methodist Homes, equity release is rapidly emerging as a core product that can help boost financial stability for cash-strapped Brits, particularly for their later life. More importantly, given its ability to cover liabilities, coupled with the fact that all plans come with no negative equity guarantee, equity release products could act as a safer and 'guaranteed' bet for pension funds looking to step up their yields in the long run.

The average pension pot currently stands at just £107,300, according to the Office of National Statistics (ONS), indicating a lack of sufficient savings for a comfortable retirement. This has led to the Equity Release Council revealing a 23% year-on-year increase in people turning to equity release – a financial service allowing homeowners to access capital tied up in their home without selling it – as a vital lifeline amidst the cost-of-living crisis. British pension funds have also long underperformed rivals, with average annual returns sitting at just 9.5% in 2021, according to Moneyfacts. This is compared to a 20.4% increase by the Canada Pension Plan Investment Board, while AustralianSuper delivered a 22.3% gain. However, Hunt's ambition to ramp up risker pension allocations is set to help the UK compete with countries such as Australia, Canada and the US, all of which are currently enjoying the largest pension returns. In comparison to the earlier products offered almost 30 years ago, mortgage-backed securities have evolved with greater underpinnings in their highly regulated origination and sales process, making them a potentially ideal asset class for pension funds.

Rudy Khaitan, comments:

"Chancellor Jeremy Hunt's plan to consolidate workplace pension schemes and allocate up to £75bn of retirement funds for investment in high growth segments represents a strategic effort to stimulate the UK economy and generate better returns for pensioners. These reforms are expected to not only enhance retirement incomes by over £1,000 a year for typical earners but also drive substantial growth in the UK's most promising companies."

"Our clients, primarily pension funds and insurers, require long-dated stable cash flows to match their liabilities which often extend to 15-20 years or more. The universe of assets that provide this duration but also meet the required risk-return thresholds is very limited."

"Senior Capital is in the business of producing rated notes backed by attractive equity release mortgage assets that are structured specifically for insurers' and pension funds' exact use cases. These assets not only offer attractive risk-adjusted yields but crucially, much coveted 17+ year duration cash flows that align with our clients' liabilities and (often narrow) regulatory requirements. By incorporating our assets into their portfolios, our clients can access profitability more efficiently and sustainably than their competitors, thus providing them with a significant edge in the increasingly competitive markets that they operate in."

About Senior Capital:

Established in August 2022, Senior Capital has mobilised in excess of $150m for the UK economy via an origination and securitisation platform which simultaneously unlocks wealth for the UK's retiree generation and allows for the easier transmission of wealth towards younger generations.