GLOBAL - New regulation, such as the introduction of Solvency II, will leave pension funds unable to cope with the eventual return of high inflation, BlueCrest Capital Management has warned.
Speaking at the Irish Association of Pension Funds investment conference in Dublin, fund manager George Cooper pointed out that steep inflation waves were usually linked to steep population growth.
He argued that the "very strong" commodities rise seen over the past decade had in fact not been matched by wage increases - leaving many national exchequers with diminishing tax returns.
He added that the new European Union fiscal stability pact - which the Irish electorate was set to ratify or reject in the coming months - was "most ridiculous" and a "European suicide pact".
He said Europe risked "Japanese-style deflation" and that the continent faced low inflation, returns and growth in the near term.
"Part of the solution to the governments' financial problems is that they have been implementing regulation to encourage pension funds to move their assets more and more into long-term nominal bonds to push their interest rates to support their economy," he said.
"The problem with that is, once inflation comes through - and I still think that is quite a way away - the real value of that debt will be almost completely eroded. Therefore, pension funds will be left with quite a huge shortfall in real terms from their investments.
"The real challenge for the pensions industry is to work out when it will be able to shift from this debt/deflation wave into this monetisation/stagflation wave."
Cooper said the "key" for this switch would be a shift in strategic asset allocation away from the long-term nominal bonds back to real assets such as real estate and equity.
He also argued that one way of addressing rising shortfalls in pension schemes was to introduce a "floating" retirement age - linked to longevity increases - although he conceded that this would not be a politically popular reform.
"We need to move towards a more flexible system and recognise that no pension fund is able to guarantee returns and pensioners have to […] share some of that risk," he said, adding that accounting changes should take account of "real" economic growth and uncertainty surrounding investment returns.
Cooper argued that, if such changes were made, then schemes would no longer be forced to de-risk through investment in long-term nominal bonds - while acknowledging that regulators had a "vested interest" in institutional investors increasing their sovereign debt holdings.