Tags: quantitative easing | stock markets | europe | pension

QE Great for Europe Stock Markets, Not So Much for Pension Funds

Monday, 25 May 2015 02:27 PM

Deutsche Lufthansa AG scrapped its dividend this year partly because of charges tied to its pension fund. Investors have been shunning the shares — and those of peers that are likely to follow suit.

An unintended consequence of Mario Draghi’s bond-buying campaign has been an increase in the estimated cost of providing for retired workers. According to an index designed by Citigroup Inc., companies with the biggest pension deficits that have been forced to reduce profit forecasts are trailing the rest of the market by the most since 2013.

While European Central Bank stimulus has been a godsend for financial markets, its impact on government-bond yields creates pressure on retirement plans, whose future liabilities rise as interest rates fall.

“Many companies are having to put extra money into their pension funds,” said Stephen Mitchell, the London-based head of global equities at Jupiter Asset Management, which oversees $50 billion. “Doing that means you have less money to distribute to shareholders.”

The phenomenon works in reverse, too. When bond rates were higher during the last two years, Citigroup’s pension-deficit gauge posted bigger gains than the Stoxx Europe 600 Index.

The Citigroup measure’s performance soured at the end of last year, as yields plummeted in anticipation of the ECB’s stimulus program.

Highest Deficit

Lufthansa has retreated 3.1 percent this year while the Stoxx 600 has surged 19 percent. The airline has the highest deficit relative to its market value, followed by Dutch insurer Delta Lloyd NV, Electricite de France SA, Germany’s RWE AG and British defense firm BAE Systems Plc, according to Citigroup data. All of those stocks have trailed benchmarks in 2015.

“Investors are starting to notice –- especially for corporates, where the pension liability represents a large percentage of the market cap,” said Alexander Altmann, Citigroup’s European head of equity-trading strategy. The Citigroup gauge is “focused on not just large pensions but also negative earnings revisions, showing that these businesses genuinely are struggling from having to top up contributions.”

Lufthansa’s pension liabilities jumped about 40 percent to $10 billion euros in the first quarter. EDF’s gained 25 percent to $23 billion in 2014.

Discount Rate

Future pension liabilities are projected using an interest rate based on bond yields, known as the discount rate. The math determines how much companies need to set aside to ensure they can generate enough returns to pay the estimated amount. Falling yields mean rising liabilities.

Globally, 12 of 15 countries with the highest pension deficits as a percentage of corporate sales are in western Europe, data by Pavilion Global Markets Ltd. show. Germany, Spain and Switzerland have some of the highest proportions.

The average pension deficit as a percentage of sales in the Stoxx 600 has increased to 4.4 percent from 3.3 percent at the end of last year, according to Pavilion.

Not every company with a widening gap has suffered in the market. Among those is BT Group Plc, said Alan Higgins, chief investment officer at Coutts & Co., which oversees about $48 billion.

BT has jumped 14 percent in 2015. The former British phone monopoly said in January its pension deficit has swelled 79 percent since 2011. Still, profits also increased every year during that period.

Company Specific

“You only have to pull up a BT graph to say it’s a factor but that the business comes first,” London-based Higgins said. “There’s no doubt it’s a company-specific negative because money gets diverted from shareholders into pension funds, but it’s not the only factor.”

With bond yields shrinking or even dropping below zero, the pressure for longer-term investors in Europe to find other higher-yielding assets has increased, according to Alex Bellefleur, a global macro strategist at Pavilion.

“The theme of corporate-pension deficits is reaching a critical moment given the sheer speed at which bond yields were moving,” said Montreal-based Bellefleur. “The broad picture to gather is that there are more underfunded companies in Europe.”

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Deutsche Lufthansa AG scrapped its dividend this year partly because of charges tied to its pension fund. Investors have been shunning the shares - and those of peers that are likely to follow suit.An unintended consequence of Mario Draghi's bond-buying campaign has been an...
quantitative easing, stock markets, europe, pension
Monday, 25 May 2015 02:27 PM
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