Pension funds must be aware of the widening duration mismatch in their portfolios as a retiring membership clashes with the prevailing low-yield environment, according to Axa Investment Managers.

In a paper on longevity, the manager said two trends – the low-yield environment and retiring baby boomers – were “superimposing” on the coming problem posed by a globally ageing population.

The research noted that the instinctive choice of many on retirement was to invest in fixed income, an approach at odds with current bond yields.

“In order to pay additional annuities in the short term, pension funds need to invest in higher-return assets such as equities or real estate,” it noted.

“With increased pressure on the short-term horizon of their liability and a chase for yield that delivers in the longer term, pension schemes are caught in a duration mismatch that keeps widening as the new demographic steady-state, post baby-boom is getting closer.

“So changes in mortality tables and structures of age pyramids imply radical changes in the temporal profile of liabilities for public and private pensions alike, which must adapt their [asset-liability matching] strategic choices accordingly.”

The research said an increased equity exposure should be considered to “satisfy the need for higher shorter-term yields”.

“Tilting the balance towards equities would hopefully compensate for depressed bond yields,” it continued. “This is a noteworthy move, as it departs from an old habit.”

It noted that the strategy had been one pursued by UK pension funds.

The paper also said there was a risk a rising dependency ratio in countries could lead to deflation among the developed nations, pointing to past experience of rising old-age ratios in countries such as Japan.

“But an ageing population could well turn into inflationary forces if an unsustainable rise in government debt led to its monetisation,” it added.

“When old-age dependency ratios reach the levels forecast by the UN in only a decade’s time, this would mean inflation next to zero or even turning into outright deflation.”