The new approach to pension risks contained in the European Union’s draft IORP II Directive would hamper long-term investment, as pension funds reacted by increasing the liability-matching part of their portfolios and reining in asset-class diversification, Allianz Global Investors (AllianzGI) has warned.
Elizabeth Corley, chief executive of AllianzGI, said: “We share regulators’ objective to ensure a well-funded and healthy pensions industry in Europe, and understand the desire to establish a level playing field for different long-term investors.
“Unfortunately, this study shows a number of unintended consequences stemming from the risk-based approach currently under consideration.”
Corley said it seemed counter-productive to discourage investment across a properly diversified range of asset classes, when this could lead to more stable returns and potentially cut risk.
AllianzGI said the study modelled the expected strategic asset allocation of long-term pension investors.
It said this showed pension funds would probably alter their behaviour in two key aspects – the liability-matching part of the portfolio would grow at the expense of the growth segment, and diversification and expected returns from the efficient growth segment of the portfolio would shrink.
“The sustainability of pension provision depends on funds being able to make investments that generate an adequate return for their long term liabilities,” Corley argued.
This needs a more nuanced and differentiated approach to risk factors – and the capital requirements associated with them – than the one being considered at the moment, she said.
AllianzGI said its study showed that the risk-based solvency regulation gave long-term investors a strong incentive to expand their liability-matching portfolios.
On top of this, given the different capital charges for certain asset classes, few asset classes will be attractive for the remaining growth segment of portfolios, it said.
These few asset classes, the model revealed, would be cash, long-duration government bonds, emerging market bonds and – in the portfolios promising higher returns – a high portion of private equity.
Most growth portfolios would be composed of only two or three asset classes, the study showed, with at most four asset classes being used at the same time.
A solution to the problem could be using an economics-based approach rather than the risk-based model, AllianzGI said.
This would allow for differentiation between specific investment categories such as hedge funds, private equity, infrastructure, commodities and emerging market equity, which would otherwise be lumped together as ‘other equity’, it said.
As a result, growth segments of pension portfolios would consist of up to 10 asset classes.