Equity markets had a volatile quarter as the ‘risk on/risk off’ trading pattern continued. The quarter got off to a good start with equity markets rallying in July, but falling back in August and once again rallying in September. Over the quarter, UK equities (FTSE All Share) rose 13.6 percent, and global developed markets (MSCI World) rose 8.0 percent.
A key feature of the quarter was the reversal in the Euro / USD exchange rate as the Euro strengthened by ten percent against the Dollar. Given the rising equity markets, it was surprising that both the fixed and index-linked gilt markets strengthened over the quarter, with yields falling sharply in August as weakening economic data was released prompting fears of a double dip recession. Yields fell further in September as speculation mounted that there would be a resumption of quantitative easing and increased buying of Gilts by the Bank of England. Overall, the tidal wave of money that has flowed into the bond market over the past 18 months has driven yields and credit spreads to levels that now look expensive relative to quality dividend paying equities, which may also offer some protection from possible increase in inflation.
The typical funding level improved 2.2 from 68.0 percent as at the end of June 2010 to 70.2 percent at the end of September 2010, as the strong rally in the equity market drove up asset values. The strong performance of the asset side of the equation was somewhat offset by the continued strength of the gilt market which drove up the expected value of liabilities.
Umar Ilyas, Head of Consultant Relations and Investment Actuary, Investment Solutions says: “The outlook for markets remains uncertain; the most notable issue from a UK pension scheme perspective concerns inflation expectations in the gilt market. The nominal yields on fixed interest gilts indicate an expectation of a low inflation environment for some time. However, the real yields on index-linked gilts are showing investor willingness to accept a negative real return over the next few years, implying an expectation of higher than ‘normal’ inflation. These imbalances are likely to continue driving the heightened volatility that we have seen.”
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