Ukraine’s independence day on 24 August also marked six months since the start of Russia’s invasion and with it a profound shift in the global geopolitical and economic balance.
These shifts will take years to play out. But the war has already exacerbated inflation, in particular by disrupting supply chains of commodities – including gas, oil and wheat – leading to fuel and food price rises.
As Ukrainian and Russian forces prepare to dig in for winter, European households and businesses are contemplating an extended tough period of gas shortages.
The leading indicators have changed. Rather than corona infection rates, German daily newspapers and websites now show up-to-the-minute indicators for fuel prices, gas supply rates from Russia, and winter gas reserve levels.
For Germany in particular, dependence on Russian gas is particularly painful, given its industrial base. Eastern European EU member states like Bulgaria and Poland are also particularly dependent on Russian gas.
The effects are already being felt in terms of higher inflation – 8.9% for the euro area and 9.8% for the EU.
As Europe has dashed to secure alternative gas supplies, the future of renewable energy investment and the energy transition has been questioned.
But there are several structural reasons to think the trend towards investment in renewables will continue, not least because of Europe’s now painfully apparent dependence on unreliable gas supplies from a pariah Russia.
One reason is the changing profile of traditional defined or guaranteed benefit schemes, for whom this year’s rise in interest rates has softened liabilities.
In the UK, for instance, the net effect of falling markets and rising interest rates has been to reduce liabilities by a greater magnitude than asset prices have fallen, resulting in a net reduction in liabilities and a net surplus. Dutch schemes have also posted better coverage ratios.
This increased headroom is likely to increase pension funds’ already high demand for yield-generating investments in areas like renewable energy. Some pension schemes will transfer liabilities to insurers, which are likely to increase their renewable investments when changes to Solvency II rules permit.
For the majority of European citizens, first-pillar pensions act as a guarantor of a decent income in old age. Those systems are likely to come under increasing pressure, meaning workplace or other private pension saving will be increasingly necessary.
For defined contribution (DC) pension schemes, 2022 has taught that portfolio diversification theory does not hold out across all periods, as bond and equity prices have fallen in tandem.
Bond-heavy default funds, often presented as ‘secure’ investment strategies, have posted strongly negative returns.
This can only erode confidence in supplementary pensions, at least in the short term. In voluntary systems, some savers are likely to stop their contributions entirely, depending on their household situation.
An obvious solution to enhance the long-term return profile of DC pensions is to boost investment in illiquid assets, including renewable energy.
Whole sectors are rallying round to boost renewable and other investments. Denmark’s pension and insurance investors have already committed to support national resilience by investing in energy production as well as projects related to the military.
In March, the country’s insurance and pension funds lobby group, IPD, called for a new public-private partnership structure that would allow institutional capital to participate in investments aimed at boosting national defence capability.
Pension investors, for instance, can provide investment capital for the real estate infrastructure – in terms of military logistics, buildings and homes – needed to underpin Denmark’s increased defence expenditure commitments.
In August, IPD said it would help finance warship procurement and help green Denmark’s armed forces. It also committed itself to an 11-point plan to support Danish energy independence. A key element will be the North Sea and Baltic energy islands – hubs for renewable energy and the smart grid.
ATP, Denmark’s €127bn labour market pension fund, is a key investor in the North Sea project.
Such partnerships for national resilience not only reflect how investment priorities are changing for countries as well as investors. They are a portent for the future as institutional investors increasingly identify close alignment with the energy and even defence policies of their governments.
Pension funds will continue serve as an important bulwark – not only in providing pension income for retirees, but also in financing the energy transition in times of choppy economic and financial waters.
Liam Kennedy, Editor