16 April, 2020


What’s happening?


  • A rebound in equities: Is the crisis over?
  • Unemployment rising in UK and US, implying a prolonged economic struggle ahead.
  • More poor economic data expected.


Focus on LDI


  • Impact of Covid-19 on the gilt market.
  • Impact of Covid-19 on pension liabilities.
  • How Mercer has managed clients’ LDI portfolio through the pandemic.


What’s next?


  • Corporate profits under pressure.
  • Expect more volatility.
  • Mercer neutral on equities, see opportunities in high yield.



What’s happening?


From the all-time highs of equity markets at the start of the year, to one of the worst crashes in decades, the last two weeks have seen a remarkable recovery. Major global indices have been rebounding strongly, including the S&P 500, which has made back almost half of its losses1.


However, we think it is far too early to call the end of the crisis, as poor economic data continues to mount:


  • UK unemployment could rise to 2m, or 10%, marking a huge increase from January2.
  • New weekly claims for Universal Credit passed 450,000 in last two weeks of March3.
  • Covid-19 could force a 35% drop in UK GDP4.
  • US jobless claims continue to climb, passing 22m5.


Focus on LDI


Many of our pension fund clients use a liability-driven investment strategy to reduce risk and match income to obligations, using a range of debt instruments and derivatives. Amid the recent turmoil, managing those derivative structures has been a key part of our role, along with carefully monitoring gilt markets and adjusting where necessary.


  • As equity markets started to fall away a little in the middle of March, a ‘flight to safety’ saw demand for and price of gilts rise pushing down yields.

  • A 10-day period of extreme market activity towards late March, as investors sold off liquid assets in favour of cash.
    • Gilt yields rose around 0.8% over this period – contrast with the biggest 10-day move over the last 10 years of about 0.5%6.

  • Re-start of quantitative easing – the purchase of £200bn gilts and bonds designed to encourage business lending and investment to reinvigorate the economy – surprised most in its size, causing value of gilts to recover sharply, with yields falling7.


Impact on liabilities - For the average client, liabilities rose 6%, fell 15% then rose 8% in the space of about four weeks. Well-hedged pensions would have seen lower levels of funding volatility, but all LDI clients will be broadly back where they started.


Impact on LDI assets – Large market moves hit all assets, but importantly our funds’ returns are in line with what we would expect. Trading has been harder and so only essential client trades have been made. Repo borrowing costs, which we use in our leveraged LDI funds, temporarily became more expensive, but our low level of trading meant we were not impacted too much.


Impact on leveraged funds – Our leverage monitoring frameworks was built specifically to ensure we are comfortable with the leverage on our funds during market environments like this. A warning level acts as an early notification to give us time to plan and give notice of a fund adjustment. At one stage in March we got quite close to this warning level8 but yields quickly fell back so there was no need for action.


Impact on swaps – We generally favour gilts over swaps as they produce a higher yield, making them a cheaper hedging asset. This yield spread has become wider over the recent turmoil, but we are pleased to have the flexibility to switch between the two when appropriate.


A rollercoaster March actually left us in a broadly similar place to where we started, but it does little to show what’s coming. As the Bank of England purchases gilts at significant volume, while the government may have to increase the amount of debt it issues to pay for supporting the economy, there remains two significant supply and demand factors that will be a key driver of gilt yield moves over the coming months.



What's next?


The numbers around the decline in corporate profits continue to be a concern, with some estimating9 they will be wiped out for the whole year. Even by the end of 2021, global GDP may still be 20% lower where it was projected to be before the outbreak of Covid-1910.


With no clarity on when or how the global economy will be restarted, we remain neutral on equities and expect more volatility across the spectrum of public markets. However, with continued fiscal and monetary policy backing up government support, we see opportunities in some areas of credit, specifically high yield11.


For more information on any of the above points, please contact your Mercer representative.


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1 Bloomberg

2 Office of Budget Responsibility 14.04.20 https://obr.uk/coronavirus-reference-scenario/

3 Pantheon Economics, As of 9 April, 2020

4 Office of Budget Responsibility 14.04.20 https://obr.uk/coronavirus-reference-scenario/

5 Department of Labor, 16.04.20 https://www.dol.gov/ui/data.pdf

6 Barclays Live

7 Barclays Live

8 Barclays Live & BlackRock

9 JP Morgan

10 JP Morgan



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