Why pension schemes are failing members in downturn
The onset of the Covid-19 pandemic has placed enormous strain on pension funds – and revealed that too few of them have properly educated their members about managing their retirement nest-egg.
Industry experts told AsianInvestor that a lack of guidance from investment industry and local pension bodies on de-risking particularly affected older pension savers as markets fell during March and April. Some were too exposed to risky assets and they had insufficient knowledge on what to do as plummeting markets ate into their pension pots.
“I know every scheme sponsor wants to make money. There’s nothing wrong with that, but helping the members in their journey is also very important,” Heman Wong, the former chief investment officer of Hong Kong’s Hospital Authority Pension Fund told AsianInvestor.
“This is the big mismatch between investors and pension providers – there is a huge gap in terms of investor education.”
Josef Pilger, Sydney-based global pension and retirement leader at EY, believes this is partly a consequence of a decade of benign conditions until early 2020.
“Telling investors to remain invested for the long run doesn’t take account of people panicking, which is what many older people do in these situations, for fear of losing their entire nest-egg,” he said. “We have not really engaged with members to prepare them for the fact that markets go down.”
It’s also partly a consequence of the rise in defined contribution (DC) pension schemes, where individuals are arguably given too much responsibility on investment decisions, compared to defined benefit schemes, where employers tend to do so.
Chart: Structure of mandatory pension systems in Asia
Source: OECD
“During a bull market, it’s easy to ignore the fact that with DC pension systems the investment professionals are outsourcing the risk to scheme members,” he said.
The latest market fall has also underscored that many pension funds have failed to sufficiently consider the danger of unlikely but profound risks such as Covid-19, Pilger added.
‘Should a fiduciary, in a mature environment with billions of dollars under their control, have projected such an event, even with a small likelihood?”
BETTER EDUCATION REQUIRED
To communicate these problems, pension funds will need to educate their savers about concepts that are relatively esoteric to the average person, such as the risk of different assets, compound interest and long-term saving horizons.
“You really have to explain to them what is the aim of pension investment, compared to just pure investment,” said Wong.
"When people say ‘I want to aim for the best return,’ this is wrong,” he added. “For a pension investor you are only aiming for the best average rate of return, because there’s no way you can buy at the bottom and sell at the top.”
It also requires informing investors that they should save differently as they near retirement, instead of putting their money in default saving funds and leaving it, as most do. One example of this is target-date redemption funds, which typically place a saver’s assets into equities for many years but gradually shift the assets into less risky debt instruments in the decade before they retire.
In contrast, Wong noted that many of Hong Kong’s mandatory provident fund savers remain heavily exposed to global equities well into their sixties.
“We have found that investors don’t generally understand asset allocation,” agreed Wina Appleton, retirement strategist at JP Morgan Asset Management in Hong Kong. “Young people will underestimate the risk they can take while older people overestimate the risks they can take, putting 100% in equities for example.”
Pension saving can also be confusing. Hong Kong's MPF, for example, has 460 investment options.
“You [shouldn’t] give people a choice of investing in India or emerging markets and then give them 400 fund choices; it’s too complicated,” he said.
COVID-19 LESSONS
Aside from efforts to better educate savers, another potential outcome from the stresses of Covid-19 is that more individual savers look to put money with large institutional pension funds, where possible.
These institutions have the capacity to employ options derivatives and other hedging instruments to insure against large drawdowns – something that individual savers cannot do.
Michael Wyrsch, chief investment officer at Vision Super in Melbourne, told AsianInvestor the fund's defined benefit plan had a tail risk protection strategy in place with Pimco for four years.
"We monetised it in late March this year and it made a profit and ensured that plan had a positive return financial year to date," said Wyrsch.
“We initially put this in place because, with volatility so low, such a strategy was cheap compared with holding bonds at low yields. That is not the case currently. We would also argue that markets are not pricing the impacts of climate change appropriately. If this continues, we believe there will be more opportunities to apply tail risk protection strategies in a value enhancing way.”
Pilger believes that a major investment change to come out of the current crisis could be a stronger focus on ‘rainy day’ funds or emergency funds. These would separate retail-focused savings schemes designed to tide over an investor for periods of three to six months. No such funds exist in Asia Pacific today, but it's possible that pension fund providers could begin to offer them in addition to standard retirement savings.
“Once you have that rainy day fund, people will [hopefully] start to think more clearly about their retirement funding,” said Pilger.