Pensions face up to 40 years of post-Covid low rates
The emergency monetary and fiscal measures taken as a response to the Covid-19 pandemic could worsening the long-term outlook for pension systems across the world for decades to come, and make investment diversification an urgent priority, say top investment executives.
Overcoming these problems will require pension funds to urgently diversify assets into areas such as alternatives, consider the benefits of sustainable investments and seek cheaper forms of investment, argued three speakers on a webinar entitled 'The Future of Pension Financing and Retirement Security', hosted by the Bloomberg Women’s Buy-side Network on Wednesday (July 22).
Ludovic Subarn, chief economist of Allianz, said it was hard to overstate the importance of the pandemic's impact on the global pension industry.
“Covid-19 hit the pension world like a meteorite [yet] most governments put them on the backburner as they try to deal with more immediate problems like unemployment,” he said.
He noted that pension fund assets dropped by 8% during the first quarter of 2020, after having grown by 14% to $33 trillion last year.
Subarn is particularly concerned by the fact that interest rates across the world were already low before the pandemic struck, and they have since been reduced even further.
“The medium-term effect is depressed real interest rates that could last for up to 40 years … because this was a pandemic [and not a traditional crisis], and it so it led to no destruction of assets per se,” he said.
That means there are no obvious catalysts for capital to be redirected and assets to rebound. The outlook is set to cause acute problems for pension funds, which have traditionally relied on fixed income investments to ensure reliable returns.
“Unbelievably we are talking about rates staying even lower for even longer,” agreed Geraldine Buckingham, chair and head of Asia Pacific for BlackRock.
“For savers and retirees that is incredibly challenging because the traditional allocations people use for retirement income simply won’t be there, and so they will have to do something different.”
John Livanas, the chief executive of the A$44 billion ($31.4 billion) State Super added that he believed the impact of Covid-19 could turbocharge an existing dispersion of economic development as the world's population expands to a predicted 9 billion by 2050.
“Covid-19 will accelerate this and perhaps could create disruptions in ways we cannot perceive, and perhaps [also] offer opportunities for risk-adjusted returns,” he added.
DIVERSIFICATION IS KEY
Allianz’s Subarn noted that while the pandemic itself is set to last at least well into 2021, the ramifications of the huge monetary and fiscal efforts to combat its economic impact will be felt across entire societies, having inevitable impacts on pension fund planning.
“We are in the second phase of Covid and in a twilight zone where the pandemic could become endemic," he noted. "As a result, we will see very different behaviours by governments, by people and by pension systems that could change the pension landscape for quite some time."
Buckingham added that the impact on pension funds were an top concern for BlackRock, given that 70% of the $6.47 trillion it has in assets under management (as of end-2019) is retirement related. She said that there is no panacea for the macroeconomic environment, and that specific investment changes would depend on investors’ particular circumstances, risk tolerance and goals.
However, there are some potential fixes that pension funds can pursue to maximise their ability to improve returns, she added.
“It’s about taking a whole portfolio approach and recognising that traditional asset allocations which were very fixed income-heavy may not be sufficient for liabilities to be met. And so, you need to look at broadening the instruments that may be used in a portfolio but doing it in a way that’s risk-aware.”
Buckingham noted that this would include investors having to diversify geographically, as well as increasing allocations to alternative assets, including property, private equity and private credit and infrastructure.
In addition, “ETFs can offer exposure to markets at lower fees and can be used as active instruments to get exposure,” she said. Plus, more institutional investors are looking towards more smart beta tools, and also sustainable investments.
“As they gain more track record, the fact that sustainable investments generate positive portfolio performance compared to traditional counterparts is becoming more apparent. In client conversations I have across Asia, sustainability is one of the themes that comes up the most.”
MANAGING DEPRECIATION
One issue facing some asset owners will be the rising need to manage negative cashflows, as aging demographics across most of the world lead to more people retiring and drawing out pension payments. That will also require a shift in investment planning, said Livanas.
“A less volatile portfolio could well return more dollars in terms of cashflow when compared to more volatile portfolio even if it has precisely same returns,” he noted.
It is an issue in which his superannuation fund is one of the earliest trailblazers; while most super funds are still cashflow positive, State Super has been established as a cashflow negative fund.
“In a way State Super is a testbed for a strategies to manage a state pension system in a volatile world with lower growth of pension assets,” Livanas said, adding that other smaller super funds look likely to also see their cash streams fall into negative territory before 2030.
What advice does he have for such funds? Livanas said long-term planning was essential. “We learned that we needed to create downside protection in portfolio construction and that derivatives were needed,” he said.
“We also needed to manage liquidity by planning for exits, sometimes very far into the future. That was especially important for illiquid or unlisted assets. We also needed to ensure we had appropriate governance and delegation to ensure greater responsiveness.
"And lastly, we needed to apply enhanced risk management and monetary tools.”
Article updated to clarify the title of Geraldine Buckingham of BlackRock.