Pensions in a hostile climate
Outside the realm of US public pension plans, where generous return assumptions and inflated discount rates are common, the medium and long-term outlook for asset classes is of serious importance to most pension funds.
The decision by the European Central Bank last month to lower rates and restart €20bn of corporate bond purchases per month is a serious one, highlighting the current lacklustre economic environment and longer-term outlook.
Depressed returns and vast stocks of negative yielding debt highlight the challenges, particularly for pension regulatory regimes that target short-term solvency and risk-free discount rate frameworks. The Dutch FTK pension solvency system belongs firmly in this category.
Long-term low asset returns are of grave importance in the Netherlands, where there seems to be no respite from the solvency trap in which many pension funds find themselves, with pension entitlement cuts looking likely for the largest funds, including ABP and PFZW. Higher rates, which would benefit funds by decreasing the magnitude of liabilities, are not on the cards.
A decade of bad news on pensions has damaged confidence in the Dutch pension system, perhaps irreparably. As the Canadian pension expert Keith Ambachtsheer points out in his September Ambachtsheer Letter, this is despite the country having one of the highest pension saving ratios in the world.
In the absence of any serious consideration of an alternative regime, Dutch and other pension funds in similar regulatory environments must make do with the current circumstances – both in terms of supervision and economics.
The ability to source and transact in yield-generating assets will be at a premium in the current lower-for-longer environment. This favours appropriate asset scale, facilitated by consolidation if necessary, as well as cooperation and partnerships with other asset owners, with asset managers and banks.
It also requires effective and supportive supervision as credit markets deepen, with regulators able to respond to and approve capital market innovations that may be to the benefit of the system as a whole. Stakeholders will need to overcome aversions to complexity and exposure to more exotic credit and loan asset classes.
It also speaks to effective investment teams, with the appropriate delegated authority to invest within a clearly specified mandate. As we highlight in this issue, good governance at the fund level is a common thread here.
For European pension funds, identifying the right skilled board members and governance frameworks should be a priority. And for those with the ability to take long-term risk on their pension fund balance sheet, traditional asset classes like equities may not be such a bad bet.
Liam Kennedy, Editor