It’s that time of year again. We look back with relief and we look forward in hope. For many end of year figures now need to be put together and yet we must also look to the year ahead. At least 2003 has not turned out so badly for most pension funds. There is a certain reassurance in knowing that at least we haven’t had four bad years in a row. But are we out of the woods yet?
Well, the stock markets are generally in better shape than earlier in the year. Interest rates have increased so liabilities are down .... But we can’t help thinking that there are still plenty of issues that are going to concern us even though the past few years have already given us so much to think about. For many investors the main concerns are if we are simply in a cyclical (and temporary) bull market within a long- term or secular bear market and if interest rates will continue to increase.
But there are other worries.
Almost every country has politicians seemingly intent on making pension fund life more complicated in the future. In the Netherlands we have a new set of initials to worry us – FTK – and a new law due to come into force in two years’ time. Switzerland is seeing its first reform of the PEBA and trying to work out the consequences. It has less time, as the new rules will apparently become effective during January 2005. In the UK, funds are waiting to be hit with new rules that include new maximum pension contributions, such as an annual contribution limit of £200,000 (e285,000) and an individual lifetime savings limit of £1.4m, though these are up for review as a result of Chancellor Brown’s recent budgetary statement.
Already, we have seen pension funds and their sponsors realise, apparently to their horror, that investing in equities now makes less sense as it results in the need for higher solvency margins (in the Netherlands this is explicitly set out in the requirements of the supervisor PVK) and increased volatility of pension costs under IAS 19 (in the UK we have the experience of FRS17).
While investing a large percentage of a fund in equities may therefore make less sense, investing in bonds is not necessarily an attractive alternative if it results in increased pension costs or lower benefits. Hence the search for alpha is a cry heard at most conferences this last year.

One thing that does fascinate me as an Anglo Saxon is that within the same week recently I heard from both Dutch and Swiss advisers that in the future we are likely to see less solidarity in their countries because of the ageing population and its consequences. Europe is heading towards a future where individuals have to take more responsibility for their own financial security. The young simply will not be able to provide for the old in the same way as our parents did for their parents.
In the UK we have already gone further down the road of individual responsibility but for us the word ‘solidarity’ never quite had the same meaning as in continental Europe. However, if we do expect individuals to take more responsibility for their retirement income then we must improve financial literacy.
A move from defined benefit to defined contribution (DC) does not in itself lead to lower pensions but if, as in the UK, it is combined with a reduction in contributions then disaster looms. Thank goodness that most of the rest of Europe is not going down that route. However, there is a decided trend towards DC in all of Europe – although I am indebted to Werner Nussbaum in Berne for pointing out that in Switzerland the move to DC does not mean a change to defined contribution but defined credit, an altogether different concept.

However, let me go back to the outlook for 2004. Markets do not seem that cheap. With an expensive euro many European companies are going to struggle to increase profits and if they don’t then most equity markets are too high. Price/earnings ratios are still above their long-term trend and if you believe in a reversion to mean, that means most markets are going to go down before they go up.
Luckily I am not paid to make a forecast, but I have to be rather nervous. I think the trend for pension funds will be and should be diversification. Play it safe, have money in a number of asset classes. We cannot forecast the future and therefore I would rather miss the top of the market if it meant that I could sleep at night with a diversified asset base: property, hedge funds, private equity, commodities, currencies, emerging markets, small cap, high yield and so on. Can so many pension funds really justify continuing to ignore so many asset classes for so long and pin so much faith in their home country equities and government bonds?
Maybe it’s time for some new year resolutions?

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