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Back in 1995, in the wake of the Maxwell affair, the Minimum Funding Requirement (MFR) was established as a means of ensuring that pensions always had enough money to pay their pensioners. Unfortunately, it was a classic case of ill-considered legislation rushed through because it was felt that "something had to be done".
We all know that gilts are supposed to be lower risk than any other investment, so it's no surprise that the extra conservatism forced on pension funds by the MFR should cause them to buy more of these. The thing is that Fools also know that gilts make a lousy long-term investment and, in real terms, a risky one too. Unfortunately, it's another example of perceived Wisdom winning over common sense and, ironically, it is the future pensioners who will suffer from this.
Some say that the MFR should be widened to enable pension funds to hold high-grade corporate bonds rather than gilts, but that would just be tinkering at the edges. It is not the gilts that are at fault, it is the whole principle of the thing. The Government is trying to tell the investment industry what is and what isn't a good or safe investment and this simply isn't its job. If the Government really wants to help us with our pensions, then it should clamp down on some of the indecent charges in the industry.
Another suggestion is that there should be an insurance fund established to bale out inadequately funded schemes. The effect of this would be that the well-managed pension schemes would have to subsidise the badly-managed. It could even be taken by some as a licence to take unacceptable risks with final salary schemes in the hope of a windfall if they come off.
As normal, the simple solution is best. The MFR needs to be ditched. Pension trustees will still have their legal obligations, highly trained actuaries will still need to approve funding levels and, if the Government tightens up on charges, much of the money may even be invested Foolishly for the long-term.
The question remains, though, of what effect this ditching would have on the gilt market. It is difficult to say what level of price distortion may have been caused by the MFR. It's something of a chicken and egg situation. On the one hand, you might say that people only invest in gilts when they are attractive, for example, relative to shares. On the other, you might say that people invest in gilts anyway and then spread out depending on the relative attractions of other investments. If you go with the first view, then you presumably think that, if gilts are overvalued, then people will tend to stick more to shares. The trouble with this is that the shares then rise to a level where the gilts become relatively attractive again. Perhaps this has been happening. I could go around in circles like this all day, but I doubt I'd reach much of a conclusion. So let's vote on it!
The question is this: The long-dated gilt yield is currently 4.5%. What do you think it would be without the effect of the Minimum Funding Requirement?
A. Not noticeably different.
B. 4.5% to 5.0%
C. 5.0% to 5.5%
D. More than 5.5%
E. I've not the faintest idea what you're talking about.
Vote Here!
Where Next?
Grappling with Gilts - Part One
Grappling with Gilts - Part Two
Investing In Gilts and Bonds Discussion Board
Pensions Discussion Board