With market volatility, oil price falls, interest rate increases in the US and QE in Europe, the investment landscape has rarely looked so clouded, making it harder than ever to have confidence that investment and risk-hedging strategies are on the right course. The slight equity market bounce following the Fed’s decision to raise rates last December has been replaced by gloom and volatility.

Despite steady, if unexciting, growth in the US, at least by historical standards, and good economic news in parts of Europe, the world lacks a clear economic narrative that might secure investor confidence.

If, as many expect, this year is a volatile one in markets with low asset returns, it will put pressure on pension systems that have barely recovered from the previous crisis. Indeed, UK pension funding, as measured by the PPF 7800 index, is still below 85%. Dutch pension funding fell by as much as 4 percentage points in the first two weeks of January alone, to about 100%. 

In the absence of such a narrative, smart pension funds will be looking at their allocations to illiquid investments like infrastructure and alternative credit. They will also be looking at alternatives to traditional market cap-weighted investments via smart beta. This is about harvesting return wherever possible, even if few stones are left unturned.

Periods of market volatility are also a good time for pension funds to consider their investment beliefs to ensure their strategies are aligned with their views on the capital markets. Kees Koedijk and Alfred Slager’s 2010 book* on the subject provides a useful framework for pension fund trustee boards and investment committees.

As markets bottom out and spreads widen beyond investment fundamentals, many pension funds will want to grasp opportunities in areas like emerging markets or high yield. This will require rigour and discipline to make sure decisions are made in a timely and efficient manner. Good boards will have ensured the right level of decision-making power is delegated to the right people to make sure execution is timely and not tied to meeting cycles.

This is also a good time for sound governance, with all views aired and debated and decisions well documented, minuted and circulated to minimise the risk of blame-sharing later if decisions don’t work out as expected. 

As long-term investors, pension funds should ensure that they act as such, even when they may be tempted to terminate managers that underperform over the relatively short term. 

Those who fixed their governance roofs in more benign times and set a sound investment and risk strategy will reap the benefits in times of stress. 

*Investment Beliefs: A Positive Approach to Institutional Investing, Palgrave Macmillan, 2010

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