Bond markets are slipping and the people overseeing the Republic's €78 billion are cheering.

Bullish stock markets have been driving pension fund performance strongly for the past few years. The most recent figures show that the average Irish managed pension fund has grown in value by nearly 19 per cent each year over the past three years.

Yet the number of pension funds getting into trouble with the regulators for undershooting rigorous funding standards is growing. The problem for most, notwithstanding the stellar market returns, is that their liabilities have been rising at an even more spectacular rate.

The first quarter of 2006, however, has seen a startling turnaround. "Based on a typical asset and liability profile, we estimate that average funding ratios have improved by 10-15 per cent between the end of 2005 and the end of March 2006," says Michael Curtin, senior investment consultant with Mercer.

"So, for a scheme with a funding level of 75 per cent at the end of 2005, this position is likely to have improved to approximately 85 per cent at the end of last month."

Curtin notes that funding ratios - the measure of pension fund assets as a percentage of accounting liabilities - have been declining for a number of years, so the recent improvement is being seen as "a very welcome development".

The principal cause of fund trustees' angst has been falling bond yields, something that leave all but the most committed confused.

Yields operate on an inverse basis - the higher the price of the underlying bond, the lower the yield. Low yields are bad for pensions, specifically defined benefit ones where the scheme member is entitled to a guaranteed payment on retirement which is based on years of service and salary.

Yields operate akin to interest rates. When it comes to setting aside sufficient funds for a member coming up to retirement, pension funds look to these yields.

Say, for illustration purposes, a pension fund knows that a specific member is retiring in a year's time on a pension of €1,000. If bond yields are running at 10 per cent, the scheme will be aware that it needs to allocate just over €900 to cover this impending liability.

However, if yields suddenly fall to 5 per cent, the €900 will only amount to about €950, leaving the fund with a shortfall that it will have to find elsewhere.

Equally, if yields jump to 15 per cent, the scheme will have a better return than it expected and this can be used to boost the scheme's funds for the benefit of other members.

So, in general, pension funds cheer when bonds are relatively cheap and yields commensurately higher. Bond prices rise as economic growth, and therefore interest rates, stagnate. Conversely, prices fall as the economy grows and interest rates rise.

The emergence of the European Union economy from its recent slumber, the subsequent triggering of interest rate rises by the European Central Bank and the expectation of further rate rises are all pushing bond values down and yields up, says Curtin. Bond yields have risen from 3.2 per cent at the end of 2005 to 4 per cent by the end of March.

"The improvement in the first quarter of 2006 represents by far the most significant rise we have witnessed over any single quarter since 1999 and sees the ratio at its best level since mid-2002.

"Gains of this magnitude are rare; Mercer has not seen any other quarter over the same period where funding has improved by more than 6 per cent," he says.

Curtin expects some pension funds that are closer to maturity will avail of the opportunity to acquire bonds at the current lows, especially as recent adverse conditions has seen funds relatively overexposed to equities. Equity allocations in discretionary managed funds now stand at between 75 and 80 per cent, according to the benefits consultants, the highest level since Mercer began tracking pension fund asset allocations back in 1988.

"Scheme liabilities are linked to bonds more than equities and you may see some taking advantage of the recent slip in bond values," says Curtin.

While the sort of turnaround in the first quarter is not expected to continue - at least on that scale - the outlook for bonds, Mercer argues, is positive.

"During 2000-2003, average funding ratios fell sharply as equities plummeted and bond yields fell. Since 2003, equities have benefited from a prolonged period of cheap money and stronger economic growth, while a resurgence of inflation fears has triggered the recent sharp sell-off in bond markets," says Curtin. "These events have brought both asset classes back closer to air value."

Curtin acknowledges that market timing is notoriously difficult and suggests that recent market moves "may provide a relatively rare opportunity for Irish pension schemes to take some risk off the table and rebalance assets while continuing to benefit from the performance potential that exposure to real assets [ equity and property] provides of the long term".