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Dear Sir,
You are right to argue that there is no easy answer to the pensions mess ("Time for a reality check", 28th January) but spoil your case by confusing current and prospective real yields.
Hedge funds and commodities both look like bubbles waiting to burst, with significant deflationary implications. Western consumers cannot service ever increasing debt levels and something unpleasant may happen in property markets. Any reality check should therefore allow for the possibility of a long drawn out deflation on the Japanese model. There is ample evidence from Japan that policy options achieve little in the face of strong deflationary forces, so it is perfectly possible that nominal yields will continue to fall with price levels falling even faster.
Such trends would lead to fatter real yields and capital gains for those who buy fixed coupon Gilts now, but lower nominal yields for those who stay in cash. The mark to market horror would not go away, and index linking would be ineffective.
Swaps are not the panacea that you assume. Somebody else has to take the other side of the trade, with potential exposure many years into the future. Now, who better to take the risk than pension funds themselves, through their burgeoning investments in hedge funds?
Yours faithfully,
David Kauders
Kauders Portfolio Management
Reading, Berks.
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