By John Stepek

Welcome to Money Distilled. I’m John Stepek. Every week day I look at the biggest stories in markets and economics, and explain what it all means for your money.

The good news on UK corporate pensions

Merryn talks to Kokou Agbo-Bloua, global head of economics, cross-asset and quant research about the outlook for 2024, and why he thinks a slowdown in the US is inevitable. But what should you buy?

There was a story over on our Markets Live blog yesterday that caught my eye, as I’d missed the original announcement. Here’s the short piece from my colleague Charlotte in full:

Leading the FTSE 250 along with AJ Bell is Coats Group, which (misleadingly) manufactures not coats, but the threads and other similar components used to make shoes and clothes.

The group’s share price is up over 10% this morning after it announced that from next year, it will stop the monthly payments it’s been making since 2021 to plug its pension deficit.

Analysts at Peel Hunt said “the agreement will release additional funds to accelerate performance and shareholder returns,” with cash flow expected to improve as a result. The company agreed to make one-off lump sum payment of £10 million, which should move its pension scheme into surplus.

Let’s unpack that in more detail. Coats Group — like many companies — once offered a defined benefit (DB) pension scheme to its workers. Also known as final salary scheme, it means that when you retire, the company pays you an income until you die. That income is based on your salary and your length of service at the company.

Nowadays, you’ll only get that sort of pension in the public sector. Today, companies almost exclusively offer defined contribution (DC) pension schemes instead (This is what auto-enrolment — which most of you will have, assuming you’re employees — pensions are).

Under DC, you put some money into the pension every month, your employer matches it, and when you retire, you use whatever you’ve managed to save over that time to fund your retirement.

Here’s the key point: a DC pension puts all the investment and retirement risk on you, the individual. If it looks like you don’t have enough money in your pension pot to fund the retirement you think you deserve, then that’s not your employer’s problem.

You’re going to have to find a way to solve that — by saving more now; investing in riskier assets (which in theory means greater long-term returns but carries the risk that it might make things worse); lowering your expectations for a comfortable old age; or all three.

A DB pension, by contrast, represents a promise by the company (or current and future taxpayers, in the case of most public sector pensions) to pay retirees a specific amount annually until they die (and then death benefits on top of that potentially). If the money available to fund that promise looks like it’s running short, then it’s on the company to deal with that.

So what’s happened here is that back in March 2021, Coats learned that its pension deficit — the expected shortfall to fund its DB pension scheme — was sitting at £193 million. The group said it would pay just over £21 million a year to plug the whole, right up to the end of 2028.

However, the deficit has shrunk to the point where Coats can pay a one-off sum of £10 million to put the scheme into surplus. As a result, it can stop paying that extra £21 million a year (of actual money, not theoretical IOUs) five years earlier than expected.

No wonder the share price jumped.

Did Kwasi Kwarteng Plug the UK’s Pension Deficit?

So what’s happened? This isn’t because Coats has done anything particularly magical with its pension fund. Across the board, private sector DB funds are now in surplus (using the most stringent definition at least — they have been in surplus before under more lax definitions) for the first time ever.

According to the Pension Protection Fund’s Purple Book (hat tip to Toby Nangle over on FT Alphaville — I hate to link to the competition but fair’s fair), there are just over 5,000 DB schemes in the UK.

On that most stringent basis that I just mentioned, they went from having a collective deficit of £483.4 billion (yup, nearly half a trillion) in March 2022, to having a collective surplus of £149.5 billion in March 2023.

Why the epic shift? It’s mostly because of rising interest rates, or more specifically, gilt yields.

On the one hand, rising gilt yields (which result in falling gilt prices — bond prices and yields move inversely) did some damage to the value of assets already in pension funds.

On the other hand, it decreases the value of their future liabilities. And the good news for DB schemes (en masse at least) is that the drop in the value of their liabilities outweighed the decline in the value of their assets.

In some ways, you could argue that Kwasi Kwarteng and Liz Truss solved the UK pensions crisis. They should be getting peerages instead of pelters. (This is a joke — haha! But if you genuinely believe that they single-handedly pushed UK interest rates up in the absence of all other factors, then this is actually the logical conclusion).

Anyway. There are a lot of points you can raise from this. You can, for example, question whether it ever made sense to force companies to pay large cash sums today to fund theoretical future liabilities based on hair-trigger methods that can result in a valuation swing of this scale in a single year.

You might also make the point that this implies that catastrophically low interest rates and quantitative easing — which were meant to tempt companies and consumers to borrow and spend — were actually disastrously stifling for the economy because they forced everyone to save more towards their ballooning future liabilities, diverting capital from more productive uses.

(All points, incidentally, that my colleague Merryn has been making for years now.)

A Potential Productivity Boost?

However, maybe now we get to look on the bright side. Coats isn’t the only company that will see money liberated as a result of its new pension surplus. The Pension Protection Fund notes that “total annual recovery plan payments are indicated to decrease by around 88% over the next 10 years, from around £11.2 billion in 2023 to around £1.3 billion in 2033.”

This is good news. The government has been hoping to encourage investment and to free up capital in the UK. Thus far its reforms have not been particularly effective by most accounts.

But maybe that doesn’t matter. Maybe the demise of the zero interest rate era and the resultant ability of companies to stop sacrificing the present to feed the demands of the distant future will help to boost productivity. (Listen to financial historian Edward Chancellor’s interview with Merryn for more on the relationship between interest rates and time).

As for the investment implications — if you’re a stock picker, it might be worth getting your slide rule out to take a deeper look at any companies you’ve ever heard described as “a giant pension fund with an ‘x’ business attached.”

Send any feedback, opinions or questions to jstepek2@bloomberg.net and I’ll print the best. If you were forwarded this email by a friend or colleague, subscribe here to get your own copy.

What I’ve been reading this morning

• A potential deal for Everton football club has run into some snags. My colleagues Giles Turner and David Hellier explain what’s going on.
• Here at Bloomberg we tackle the questions that matter most. And sometimes we also debate who does the best mince pies? Here a top chef ranks 12 pies, from best to worst. (Actually, there’s a massive Christmas money-saving tip in here, given the winner, so it’s by no means completely off-topic).
• And where better to work off your mince pie glut this Christmas but at a luxury spa? My colleague Sarah picks four of her favourites in or nearby London (it’s a tough job, etc.)
• Don’t worry about being replaced by a robot — AI will create more work than it destroys, says Clive Crook.

Mid-day markets

Looking at wider markets — the FTSE 100 is up around 0.4% to 7,540. Gold is flat at $2,030 an ounce, and oil (as measured by Brent crude) is up 1.9% at $75.50 a barrel. The pound is trading 0.1% lower against the US dollar at $1.258.

Quote of the day

Putting a number on… the Bank of Mum and Dad

Before you go…

We’re in a world where politics and political interventions matter far more to markets than they did in the pre-2008 era of consensus, globalisation, and voter apathy. So be sure to read my colleague Allegra Stratton’s daily newsletter, The Readout, to keep up.

The main stories to watch out for next week include:

• It’s a busy week for central banks — the Bank of England is expected to keep the key UK interest rate at 5.25% when it announces its latest decision on Thursday. The Federal Reserve and the European Central Bank deliver their latest decisions, on Wednesday and Thursday respectively. On Tuesday, we get an update on the UK labour market when unemployment and wages data is released.
• In corporate news, companies reporting include bankruptcy specialist Begbies Traynor and defence company Chemring Group.

Read more @bloomberg