By Joseph Neu
Managers of frozen or closed pension funds need to be prepared for transitional periods.
Managers of pension funds on a decumulation journey (with more cash flows going out of the plan than coming in) need to be wary of the different dynamics in this stage of the savings cycle. Investors are more vulnerable to shocks and more susceptible to forced selling, all with a greater time dependency on realizing returns.
This is particularly true during periods of major, rapid, institutional transitions that Abdallah Nauphal, CEO of Insight Investment, calls “interregnums,” which can create increased volatility in asset markets. Mr. Nauphal shared his views at our Pension and Benefit Roundtable, sponsored by BNY Mellon, of which Insight Investment is a part.
What to do? Part of the answer for investors is to focus their investment strategies on achieving specific outcomes rather than focusing on short-term volatility. This can only be done if pensions have a strategy in place to manage their cash flows ahead of time.
Pension plan solutions need to be tailored to individual plans’ situations. For example:
- Add certainty. The better funded a given plan is, the easier it may be to design a strategy to maximize the certainty of meeting its objectives, e.g., minimizing funded status volatility.
- Add resiliency. For plans that are significantly underfunded, it also becomes important to find ways to increase the resilience of the overall portfolio construction/asset allocation.
This is consistent with what I wrote at the start of the year in that now is the time to think about resiliency, or what Nassim Taleb calls being anti-fragile.
In case you’re curious, the road map Mr. Nauphal laid out for the current interregnum would look like this (see graphic on page 1):
- The key developed economies move from exploring the limits of monetary policy to pursuing a monetized fiscal expansion: “Governments are prepared like never before to intervene in our economies,” he noted, but this activism may not stave off a crisis.
- Monetizing the fiscal expansion leads to inflation.
- Inflationary conditions lead to a crisis from which a new order emerges.
So, let’s hope the new order that emerges is an extremely prosperous one—e.g., an Industrial Revolution 4.0 that’s fueled by smart machines and AI—and the crisis that it begets is not too painful. Meanwhile, more of us will want to get on the glide path that guides us through the current interregnum.
Negative-Rate Concerns Spread to Pension Funds
Although the likelihood of negative interest rates in the US still seems remote, in Europe they’ve been a reality for several years, and pension funds are now grappling with what that means.
In another discussion at the Pension and Benefits Roundtable, the head of pension investments at a multinational corporation (MNC) with several European funds noted it will be the first time in his company’s history that it will have to use negative interest rates to value liabilities, specifically in a Swiss fund. He noted looking at IFRS accounting rules that apply to European companies and concluding a negative number must be used in those calculations, “even though it doesn’t sound right. You promised a $100 pension to someone, and you knew it wouldn’t be more than that, but today you have to say that my liability is $105.”
Falling rates are no fun either. Other participants noted that falling rates, even if not yet negative, are also problematic given the growing pressure they put on banks, and ultimately their services. One noted the impact of falling rates on her company’s P&L and said her team is now concentrating on manager searches and debating the value of passive versus active managers. “Do we think active management would provide us with a bit more of a defensive posture, in our equity lineup?” she said.
Cutting costs. The topic of centralizing pension plans across European countries arose during the roundtable, to enable pensions facing the challenge of negative rates to cut costs while potentially smoothing out imbalances when some of an MNC’s funds across different countries are well funded and others in the red. A participant noted that Belgian law permits pooling pension-fund assets, and his team has considered the move with respect to funds in smaller European countries—Belgium, Austria, etc.—but the complexity has hindered progress. “We don’t see blending Germany and the UK, Switzerland and the UK, or those in other large countries,” he said.
