The ways in which values change as macroeconomic conditions change can be complex and not even obvious. One recent one, over the past couple of years, makes older British companies more valuable relative to newer ones. Now, of course, this doesn’t mean that all older companies are now worth more than all new ones. Rather, this is that the sector of older is, for this one reason, now worth more than they were. And in a manner that doesn’t apply to newer British companies – the cause is rising interest rates.
The cause here is interest rate rises and the effect works upon pensions funds. This is real too – this isn’t just some vague handwaving about possibilities. Wincanton rose 10% when their numbers were released. Mothercare similarly rose 10% (although there might have been other factors there too). However, it only works on older companies. New ones simply don;t have the features that make this a thing.
Pensions Funds and Interest Rates
Older companies have “defined benefit” pensions plans. Pensions earned while working are guaranteed and related to earnings. OK. Those plans all stopped taking new entrants a decade and more back (except for public sector workers of course) so newer companies don’t have them – they have defined contribution ones. The difference here is that the second type means that the pension is whatever the investments give as income. The first type means that the company is responsible for putting more money in to maintain payments if the investments don’t work out. It’s a big, big, financial responsibility – the coal mines no longer exist but the pensions most certainly do. The pension fund at BT is much larger than British Telecom. It’s an important thing.
Now, over the past 15 years companies have been paying very heavy costs for this arrangement – that’s why everyone stopped having such pensions for new entrants. Because when interest rates fall then the calculation of how much capital you need to pay a future pension rises. Considerably in fact. Of course, the assets you own also rise in value at the same time, all those bonds rise in capital value as interest rates fall. But pensions liabilities go on for decades and decades – someone paying into a pension in the 1990s might not stop receiving their pension until the 2070s. Well, 2060s at least. So, as interest rates fall the capital cost of future pension provision rises more than the value of the bond portfolio does. Vast pensions funding gaps open up.
Interest Rates Are Rising Now
Ah, but now we’ve got interest rates going back up again and the opposite happens. The bond holdings fall in value but the tenor (the period of time they’re held for) is shorter than the pension liabilities. So, the capital requirement to keep the pension fund solvent falls. Actually, it can reverse. Wincanton “defined benefit pension scheme showed an actuarial surplus of £3.9m, compared to an actuarial deficit of £154m at 31 March 2020. “ That £160 million difference now means that Wincanton can pay dividends, buy back stock, is freed from the restrictions of distributing capital to shareholders because now that the pension fund is fully funded it doesn’t have priority. Mothercare: “Pension scheme deficit materially reduced to £35.0 million (March 2020: £124.6 million). Pension contributions reduced by £38.8 million to £34.9 million.”
These are, as we can see, big, big, numbers. They’re material, they impact upon dividends and profits substantially. And here’s the thing. Legally these pensions fund deficits only get checked once every three years. So, while this reduction in the pensions deficits has been going on as interest rates rise it’s not obvious that every company has booked the change yet.
Now, note what’s necessary here. It needs to be an older company – newer ones simply do not have defined benefit pensions funds. Since interest rates went to near zero back in 2009 and so on these costs have weighed heavily upon reported profits and distributions of older British companies. Now that weight is being lifted. But we’re only going to see the full effect as that three-year cycle comes around to each company.
Takeaways
No, no, I’m not. I’m not going to go and check the accounts (BTW, an easy place to do it is in the company reports section of the Stock Exchange site) to see when the next pensions revaluation is for each company. You can work it out for yourselves (another hint, probably 3 years after the last one). But there’s definitely a cute little trade there for anyone willing to put the research time in. Not all but very large numbers of the pensions funds deficits are going to be solved simply by interest rates having risen. We can expect a rise in the shares concerned upon announcement of this fact.
Good luck and good hunting.
