Buck Bond Group
A shifting landscape: Opportunities and threats

A shifting landscape: Opportunities and threats

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We have seen massive change in the political landscape over the last 30 years, starting with the fall of the Berlin Wall and, since, the collapse of the Soviet Union, the creation of the EU, the introduction of the Euro and China entering the World Trade Organisation. This has provided the backdrop to increasing globalisation and inter-reliance between different economies. While there have been challenges along the way, the result for many has been falling inflation, falling interest rates and an improvement in living standards – in part driven by these political developments.

However, COVID-19 and now the war in Ukraine have thrown these expectations out of the window. The unfortunate reality is that both these events were lurking in the shadows before manifesting themselves, though their effects may now feel like a shock. Pandemics are an ever-present danger and whatever the particulars of COVID-19, climate change is likely to increase the future risk of similar events. War, sadly, is a man-made tragedy from which we never seem to learn – with the risks to Ukraine becoming evident when Russia annexed the Crimea in 2014.

The war in Ukraine has thrown the East and West’s jockeying for economic power into clear perspective, and it has now turned into widespread economic war with Russia. There has been much conjecture over many years as to whether – and for how long – the U.S. Dollar will retain its status of reserve currency, and the associated privileges this endows on US citizens. While we are not predicting an imminent collapse of the U.S. Dollar, the nature of sanctions posed on Russia (with the US having sought to prevent Russia from accessing its USD reserves) may lead some to question the merits of keeping their own reserves in U.S. Dollars. Indeed, just as Europe is now looking for ways to reduce its reliance on Russian oil and gas, so too may Russia and China look to facilitate an alternative reserve currency and thereby reduce their reliance on the U.S. Dollar. The advent of cryptocurrencies makes such an objective much more realistic than it was just a decade ago.

The confluence of the pandemic, elevated climate change risks and global powers exerting ever greater economic pressure on each other is likely to create a prolonged period of increased uncertainty. This is likely to manifest itself in continued risks to supply chains, aggravated by commodities being used as political tools. This increases the risk of inflation settling at higher levels than those to which we have become accustomed. All of this also rests against a background of an ageing population, which brings its own challenges and inflationary risks.

With this in mind, we believe trustees should take the following actions:

  • Consider whether journey plans remain appropriate. These are often structured such that risk reduces steadily over time. Is this the best way forward in the current environment, or would a ‘lower for longer’ journey plan be more appropriate?
  • With gilt yields rising and credit spreads widening, assess whether a portfolio of investment grade credit and gilts can be constructed, which would match the scheme’s cash flows. Such an approach may mean a slower but steadier path to buy-out.
  • For schemes needing a higher return (or willing to take more risk) consider underweighting interest rate duration and investing in assets expected to benefit from higher inflation. There are many options available to trustees (e.g. floating rate debt, infrastructure equity) which we would be happy to discuss further.

Important notice: This article is for Professional investors only and was written as at 19 May 2022. The article is generic in nature and should not be regarded as providing specific advice or a recommendation of suitability. No action should be taken without seeking appropriate advice, taking account of how the market environment has changed since the date of this article. There can be no guarantee that the opinions expressed in this document will prove correct.