Credit Ratings and UK Defined Pension Fund Portfolio Values

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.