QE: Uncertainty is Queen
It is unsurprising that Dutch pension funds sought to voice their concerns about the effect of QE on their sector before that decision was ratified. Indeed, they approached Klaas Knot, president of the Dutch National Bank, ahead of the ECB’s January QE announcement to do exactly that. Knot is also the Netherlands’ member of the ECB governing council.
Evidently, the Dutch pension funds and other opponents of QE were unsuccessful in their overtures. Mario Draghi, ECB president, has since argued that QE is in the best interest of pension fund members because the alternative, deflation and a stagnant economy, would be much worse in this macroeconomic chess game. On the balance of the facts it is hard to argue with that.
Any short-term rise in euro-zone interest rates seems distant from this perspective, the recent spike in Bund yields notwithstanding. But smart institutional investors are preparing for this scenario; the ‘taper tantrum’ of 2013 was a salutary reminder of what can happen when the market is unprepared for a rate rise, even if one that does not materialise. And there is growing recognition that the uncertainties surrounding eventual rate rises mean funding levels may not rise back above the safety margin.
Interest rate hedging itself has also not fully immunised pension liabilities as recent Dutch experience shows: despite record QE-fuelled asset returns, portfolio growth has not been sufficient in many cases to keep up with growing liabilities. Dutch funding levels have fallen; UK funds are nowhere near being out of the woods despite recent rises in nominal and inflation linked Gilts and strong equity markets.
It is now time to re-think some cherished ideas; the concept of de-risking is essentially meaningless in an environment where even record returns cannot make up for declining funding ratios in so many cases. Risk transfer to an insurer is too costly for most.
Funding ratios matter because of the legal obligation and the structure of the pension promise. Now the nature of those promises is once again coming under scrutiny, in part due to the extraordinary measures of central banks.
In the Netherlands and elsewhere there is gradual recognition that some form of DC with collective risk sharing is better than the imbalances and imperfections of the current system. Just as the Netherlands is looking the UK’s liberalisation of at-retirement options, the UK could learn much from the Netherlands on pension system design and collective risk sharing.
While it might be hard to argue that pension fund members are better off in the long term under QE than without it, history might judge the ECB’s QE programme to be the endgame in a long and not entirely fair chess game between pension funds and wider economic forces.