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Credit Ratings and UK Defined Pension Fund Portfolio Values

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  • Martin Sullivan

    ()
    (UWE, Bristol)

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    Abstract

    The emergence, in recent years, of large financing deficits in the portfolio values of UK DB pension funds, along with changes in the way such funds are valued by actuaries, has led fund managers to increase the weighting of fixed income securities, including corporate bonds, relative to equities in the portfolios they manage. Since bond prices tend to be less volatile than those of equities, greater bond holdings are attractive in the context of an accounting framework which now values funds on the basis of the current market values of the assets they hold and does not permit the smoothing of asset values over time. When selecting the fixed income securities to be held in the portfolios they manage, fund managers will have regard to the credit ratings assigned to corporate bond issuers. Through a consideration of some key credit rating metrics, and a survey of some relevant literature, this paper seeks to shed light on the ways, and the extent to which, the actions of the credit rating agencies may impact upon the values of defined benefit pension fund portfolios. The paper is organized as follows. Section i provides a general introduction to the theory and practice of credit rating and notes the relevance of credit ratings to defined benefit pension funds. Section ii presents a discussion of pension fund portfolios and their asset allocations. Sections iii and iv analyse the significance of credit ratings and the behaviour of rating agencies for defined benefit pension funds. Section v draws some tentative conclusions and offers some suggestions on the direction that future research on this topic might take.

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    File URL: http://carecon.org.uk/DPs/0909.pdf
    File Function: First version, 2009
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    Bibliographic Info

    Paper provided by Department of Accounting, Economics and Finance, Bristol Business School, University of the West of England, Bristol in its series Working Papers with number 0909.

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    Length: 16 pages
    Date of creation: Jul 2009
    Date of revision:
    Handle: RePEc:uwe:wpaper:0909

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    Web page: http://www1.uwe.ac.uk/bl/research/bristoleconomics.aspx
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    Keywords: credit ratings; pension funds; portfolios;

    This paper has been announced in the following NEP Reports:

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    1. ., 2004. "Market dynamics associated with credit ratings: a literature review," Financial Stability Review, Banque de France, issue 4, pages 77-93, June.
    2. John Y. Campbell & Glen B. Taksler, 2002. "Equity Volatility and Corporate Bond Yields," NBER Working Papers 8961, National Bureau of Economic Research, Inc.
    3. Hand, John R M & Holthausen, Robert W & Leftwich, Richard W, 1992. " The Effect of Bond Rating Agency Announcements on Bond and Stock Prices," Journal of Finance, American Finance Association, vol. 47(2), pages 733-52, June.
    4. Gonzalez, F. & Haas, F. & Johannes, R. & Persson, M. & Toledo, L. & Violi, R. & Zins, C. & Wieland, M., 2004. "Market dynamics associated with credit ratings: a literature review," Financial Stability Review, Banque de France, issue 4, pages 53-76, June.
    5. Caton, Gary L & Goh, Jeremy, 2003. " Are All Rivals Affected Equally by Bond Rating Downgrades?," Review of Quantitative Finance and Accounting, Springer, vol. 20(1), pages 49-62, January.
    6. Bodie, Zvi, 1990. "Pensions as Retirement Income Insurance," Journal of Economic Literature, American Economic Association, vol. 28(1), pages 28-49, March.
    7. Blake, David, 2000. "Does It Matter What Type of Pension Scheme You Have?," Economic Journal, Royal Economic Society, vol. 110(461), pages F46-81, February.
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