Key Post A rough year

[Colm Fagan]

Are you saying that pension funds are compelled to buy bonds? If so, why and by whom?

First of all, @Sunny was referring to defined benefit (DB) pension schemes, which typically promise a pension of a percentage of earnings. He/she was not referring to defined contribution (DC) pensions of the type I have and that I've been writing about in my diary. Under a DC pension arrangement, the pension from retirement is whatever can be afforded with the fund accumulated by that date.
Trustees of DB schemes are expected to invest in assets appropriate to the liabilities of the scheme. The liabilities at any balance sheet date are fixed in nature (continuation of current pensions - plus any increases promised in future - for employees already retired, pensions starting from normal retirement date, calculated by reference to current salaries and service to date, for current employees). This pushes the trustees toward investing in bonds to match those fixed liabilities.
It is a bit too strong to say that they are "compelled" to invest in bonds, but they are expected to have enough in the fund each year to meet a minimum funding standard set by the Pensions Authority. If they have a substantial proportion of the fund invested in equities, its value could fall significantly if there's a bad year on the stock market and they may not have enough at year end to meet the minimum funding standard. The value of bonds could also fall, but a fall in the value of bonds would (usually) be due to an increase in interest rates (bond values move inversely to yields). The rise in interest rates would also cause the value of the liabilities to fall (the value of a fixed debt payable a number of years into the future is less if you can expect to earn a higher interest rate in the meantime). Ideally, the assets and liabilities would move in tandem. The same isn't true if the fund is invested in equities.