European pension funds feel the sting of negative rates

Institutional investors across Europe are reviewing their bond portfolios as negative interest rates reduce income and the ability of funds to match and hedge liabilities.

Mercer surveyed 1,100 institutional investors with assets of €930 billion across 14 European countries. One finding is that investors are keeping faith with emerging markets despite poor performance since 2013. Mercer said it was encouraging to see investors taking a long-term view on emerging markets, which it continued to advocate as part of a well-diversified growth portfolio.

As negative bond yields increase in Europe, the survey found that there has been a move away from domestic government bonds to higher yielding non-domestic government or corporate bonds. However, responses to negative yields vary across Europe due to regulatory constraints, the availability of acceptable alternatives and investor risk tolerance. The survey also found that the proportion of pension funds which are cash flow negative, when monthly outgoings exceed monthly contributions, has risen from 37% to 42%. This has increased interest in income-generating strategies and cash flow financing strategies. Among UK plans which are currently cash flow positive, 44% believe they will become cash flow negative in the past five years, 34% between five and 10 years, 12% between 10 and 15 years, and 11% in over 15 years’ time.