Investment Update: The Case for Gold in UK Defined Benefit Pensions

Necati Bahadir Bermek

With the rapid growth in funded ratios over the past year, an increasing number of defined benefit (DB) pension schemes in the UK have considered their investment approach for the final stage – the time when a scheme goes from an underfunded regime to a regime fully funded or even having a surplus.

Our analysis suggests that gold is an effective addition to a DB portfolio, helping a plan achieve its desired endgame by:

  • contribute to long-term growth, and
  • providing diversification that helps reduce funding level volatility.

How have UK DB pension schemes fared recently?

To answer this question, we look at the evolution of the PPF 7800 index published by the Pension Protection Fund (PPF) since 2019. The index shows the estimated funded position for DB pension plans in the universe eligible under the PPF and is based on the remuneration paid by the PPF, which may be lower than the benefits of the full scheme. At the end of 2019, the plan’s overall funded ratio (the ratio of a plan’s total assets to liabilities) was 99.4%.

In the first half of 2020, one of the immediate consequences of the COVID-19 induced crisis is that yields collapsed, along with equity markets. Together, these two developments posed a challenge for UK DB pensions (Chart 1). With the increase in the present value of liabilities and the decline in the value of assets, aggregate DB plan deficits widened to lows of 92% in July 2020.

Chart 1: COVID-19 has created significant challenges for UK DB pensions

Historical aggregate funding position and funded ratio of plans in the PPF universe*


Since then, funding levels have steadily increased. Strong returns from growth assets have been a key driver of significant improvements in plan funding levels in 2021, with global equity markets reaching new highs following a strong economic recovery across the world.

More recently, for a traditional DB plan, especially a closed plan, a higher yield curve – proportional to rising inflation – has provided another tailwind by lowering the present value of liabilities.

At the end of June, the PPF 7800 index shows funding levels were at 120%, levels not seen in a decade. And while disaggregating the data reveals that there is significant dispersion in funded ratios across plans, it is important for defined benefit plans to seek to maintain the funding gains made over the past year. This is especially true as concerns surrounding the global economic environment continue to mount and growth-oriented assets remain under pressure.

Managing certainty of results

Given the recent improvements in the funded status of UK pension schemes and the scale of the macro challenges, we believe DB schemes should consider ways to protect their growth portfolio and narrow the range of potential outcomes. This would increase the probability of reaching the chosen endgame (Chart 2).

Chart 2: Pension plans should seek to increase the certainty of reaching their endgame

Hypothetical evolution of DB funding levels based on different strategies


Identifying a target return to be achieved within a specific time frame to cover all liabilities is important for DB plans. But achieving that result with any level of certainty can be difficult. One of the most important questions for investors today is whether the higher interest rates that are coming on suddenly and quickly can indeed result in a “soft landing” for the global economy. Past experience suggests this will be difficult; the tightening often preceded the slowdowns.

Since 1976, for example, the Fed has managed to raise rates only twice without then plunging the U.S. economy into a recession over the next two years – in 1983 and 1994 (Chart 3). Only time will tell if the latest round of Fed hikes will successfully fight inflation without a recession – or if a recession will be needed to kill inflation.

Chart 3: Fed funds rate hikes have generally led to a recession in the United States

Six of the last eight rides have followed this pattern*


What makes gold a strategic asset for DB pension funds?

Our analysis shows that gold is a clear complement to equities and broad-based growth portfolios. A store of wealth and a hedge against systemic risk, gold has historically enhanced risk-adjusted portfolio returns, generated positive returns, and provided liquidity to meet liabilities in times of market stress.

Investors have long viewed gold as a beneficial asset during times of uncertainty. Yet historically, gold has generated positive long-term returns in good and bad economic times, outperforming many other major asset classes over the past 20 years (Chart 4).

Chart 4: Gold has outperformed most broad-based portfolio components over the past two decades

Annualized returns of the world’s top growth-oriented assets in GBP*


The diverse sources of demand give gold a special resilience and the potential to generate strong returns in various market conditions. Gold is, on the one hand, often used as an investment to protect and enhance wealth over the long term, but on the other hand, it is also a consumer good, via the demand for jewelery and technology.

Additionally, while it is sometimes difficult to find effective diversifiers, with many assets becoming increasingly correlated as market uncertainty increases, gold is different in that its negative correlation to equities and other risky assets increases as those assets sell (Chart 5).

Chart 5: Gold becomes more negatively correlated with equities during market sell-offs

Correlation of Global Equities to Gold in Various Market Environments*


With few exceptions, gold has been particularly effective in times of systemic risk, delivering positive returns and reducing overall portfolio losses (Chart 6).

Chart 6: Gold offers downside protection

Performance of global equities, UK gilts and gold (in GBP) during times of systemic risk*


A DB portfolio that includes gold can help reduce funding ratio uncertainty

Let us now illustrate how an allocation to gold in a DB portfolio could help reduce funding ratio uncertainty and increase the chances of reaching the endgame of a pension plan.

Table 1 (p.4) describes two hypothetical diagrams. We assume that each plan has a target time horizon of 10 years to become fully funded and has the same initial funding level (85%). We also assume that the trustees of these plans are comfortable using a leveraged Liability Driven Investing (LDI) strategy to stabilize their funding ratios and have a target coverage ratio equal to the initial funding.

For modeling purposes, we also assume that both plans have a required return of 4.3% with an asset mix of 30% return seeking / 35% credit / 35% liability coverage and a level leverage of 3 in the corresponding portfolio. The first pattern has a typical yield-seeking asset allocation, i.e. global equities. The second scheme holds a diversified mix of stocks and gold.

Table 1: Hypothetical diagrams with the same time horizon but different growth portfolios

Key Features and Strategic Asset Allocation of Two Hypothetical Plans*


Chart 7: The uncertainty of reaching the chosen endgame could be reduced with an allocation to gold

Paths taken by two hypothetical plans to become fully funded*


In addition, volatility in the level of funding can have a significant impact on pension plans. We witnessed this during the market turmoil of March 2020. Next, we compare how our two hypothetical regimes would have fared during this period – assuming no leverage for the simplicity and an initial funding ratio of 100%.

The hypothetical scheme with gold allocation saw a reduction in funding ratio volatility, reaching a level of 0.93 compared to 0.91 for a scheme without gold (Chart 8). The benefits of the lesser reduction in this scheme are twofold: assets are not required to work as hard to recover, and the management of the sponsoring employer’s balance sheet risk is also facilitated.

Chart 8: An allocation to gold could have reduced funding ratio volatility during the COVID-19 induced crisis

Funding ratio of two hypothetical plans with and without gold*



Following significant volatility in funding levels over the past two years, there is an increased focus on risk management among DB schemes. The potentially higher returns from equity exposure will continue to be important, particularly for plans looking to reduce the time to their long-term funding goal, close any funding gaps and provide protection. against longevity risk. Nonetheless, systems focused on maximizing the certainty of outcomes should have a preference for an asset mix that provides a higher level of certainty of achieving those returns over a given period.

As our hypothetical case study demonstrates, an allocation to gold can help mitigate the main risk faced by defined benefit plans – namely uncertainty about the ability to pay pension benefits – by providing a long-term growth potential and diversification that helps reduce funding level volatility.


Asset class forecasts:

  • UK corporate stocks and bonds: We used State Street Global Advisors’ long-term asset class forecasts for the third quarter. These forecasts are forward-looking estimates of total return, generated by a combined assessment of current valuation measures, economic growth, inflation prospects, ESG considerations, return conditions, as well as historical price patterns.
  • The corresponding portfolio is modeled using the yield to maturity of nominal 20-year UK government bonds with a cost of leverage modeled using SSGA long-term asset class forecasts Q3 2022 for UK cash
  • Gold is modeled using Qaurum. The World Gold Council has developed a framework to better understand the valuation of gold. Our gold valuation framework powers our web-based tool, Qaurum, which allows users to assess the potential performance of gold under customizable hypothetical macroeconomic scenarios. For the analysis, we have used an expected return of 3.5%, which is the long-term average implied return for gold under the five predefined macroeconomic scenarios provided by Oxford Economics and published on July 7, 2022.

Original post

Editor’s note: The summary bullet points for this article were chosen by the Seeking Alpha editors.

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