As concerned pension funds are flocking to 'safe' assets or buying equity protection, John Gray points out there is no such thing as a 'free lunch' in life
There is an ancient saying attributed to Saint Teresa of Avila that "More tears are shed over answered prayers than unanswered ones."
I think that most pension trustees have been grappling with what to do about the ongoing highs in the equity markets and whether (or when) there will be the inevitable market correction. Returns have been exceptional for some time and many funds have made a lot of money. Is it time to run to safety or is it truly ‘different this time'?
Many active fund managers have been sitting on their hands for a long while, refusing to invest in what they consider to be an overvalued market that is bound to crash and destroy value. However, this has impacted on their performance, which has suffered accordingly.
Some funds are moving out of equities, realising gains and locking into what they believe to be ‘safer' and less volatile asset classes.
Other funds are buying complex ‘insurance' products that for a fee will protect against market losses or can even offer protection for no apparent cost (instead of an upfront fee you give up on gains from possible future market rises).
There is, of course, no such thing as a ‘free lunch' in life. Most open public and private defined benefit (DB) schemes (yes there are still open private schemes) are dependent on taking long-term equity risk to meet their obligations. If they reduce their exposure to equities then they may have to increase contributions.
There is also the argument that pension funds are in for the long run - so why worry about short-term temporary movements? Equity markets always recover eventually and then go on to more record highs… don't they?
I remember a few years ago funds being strongly lobbied to take out similar insurance products. Since then markets have risen even further and if they had bought then this would have meant unnecessary costs and/or lost equity return opportunities.
To complicate matters further for us poor trustees, there are also voices out there arguing the risk is overstated and that equities are not necessarily overpriced in all markets. Twice now in recent months I have attended pension conferences and heard positive views on the near future. This included a respected economist of a major international bank and a senior investment manager of a large mainstream equity fund. There were ‘ifs and buts' expressed about the impact of Brexit and Trump etc. But it was not at all doom and gloom.
Meanwhile, elsewhere I have heard very robust arguments that we are about to go over a cliff edge.
The elephant in the room is fund valuations. If the market does crash at the eve of a valuation and it results in massive deficits then that will cause all sort of problems for these funds. So you could understand the temptation for funds to be defensive and ‘safety first' even though there will be costs.
Let's leave aside for the moment about whether it is really a good idea to drive pension investment decision-making on the basis of what is essentially an artificial ‘snap shot' of inherently volatile valuations. I think it does make sense to crystallise some of your gains and take defensive measures. If your fund is currently nearly fully funded (like most local government pension funds) then why take the risk?
The current positive funding level of so many DB funds does make you wonder why so many people wrote off DB schemes and closed them at huge cost in the private sector. But let's leave that aside for another day as well.
John Gray is chair of the Newham Council Pension investment and accounts committee, writing in a personal capacity
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