KPMG: UK Equities for Long Bond Swaps 'Just Not Going to Work'

October 17, 2006 ( - There's a serious problem with the notion that UK defined benefit pension plans can flee equities for long bonds - demand will outstrip supply by a long shot.

That was the recent warning issued by KPMG along with an assertion by its UK head of investment consulting, Patrick McCoy, that a bonds swap strategy as a way to cut risk is “just not going to work,” according to an IPE news report.

KPMG research has found that demand for long-dated bonds will outstrip supply by up to four times. According to the research, if DB plans sought to transfer all their equity holdings into sterling long-dated bonds, the likely requirement would be around £515 billion – with an estimated £100-150 billion available, IPE reported.

“The theory that pension funds will transfer investments out of equities into sterling long-dated bonds to reduce their exposure to the equity market and reduce their risk profile once the value of these equity holdings increases to cover their deficits is fundamentally flawed,” KPMG said. “The bonds are not available. The squeeze in the bond market is likely to continue to suppress yields. Pension funds will have to look at alternative investment strategies focused on more diversified portfolios or use complex financial instruments.”

KPMG estimates UK DB plans have around £750 billion in assets, with many of them in deficit. When they attain a fully-funded position, it is expected that these funds will try to cut their equity exposure to rebalance their asset allocation and reduce their risk profile, KPMG notes.