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On the Record: What is your outlook for 2016?

Three pension funds share their views on the outlook for 2016

Ericsson Pensionsstiftelse
Sweden
Christer Franzén, CIO

• Location: Stockholm
• Assets: SEK18bn (€1.9bn)
• Ericsson’s Swedish pension foundation

Our fundamental macro view is that 2016 will be a similar story to this year. Growth will be slow but positive. In the European Union, the stock market has lagged significantly over the past five years. Therefore, if investors believe that QE [quantitative easing] will continue to work, we could expect that the EU stock market will catch up with the US market. Emerging markets will continue to struggle, so we will not put too much faith in them.

For the US and Europe, we think growth in China will decide what the markets will look like next year. If China misses growth expectations, it might affect the US and EU stock markets negatively. But viewed from China, it’s the other way around; as long as the US and Europe continue to grow, China will be fine. The fate of the two macro regions is intertwined. 

Investors will anticipate that the Federal Reserve will start hiking rates and that the ECB will do more quantitative easing. However, it all comes down to fundamental growth. If global GDP is between 2% and 3%, the markets will react positively, but I think that we will see a similar dynamic to this year, where sudden volatility has hit the markets. Asset price growth will be positive, but too low to support pension funds’ return targets.

So a pension fund’s strategy will depend on how well capitalised it is. If it has done really well in the past few years, it will probably lower its return target and keep risk levels low. This is what we might do, because the markets will be volatile and we don’t want to build too much risk in our portfolio.

I think that the over-reaching that has been done in the area of regulation and policy, including QE, has basically made markets less functional. It’s unfortunate and will not benefit pension savings.  

Political variables are now more influential in the markets, and they are very difficult to model. A solution is to invest more in the unlisted markets and avoid the public markets when possible. The risk/reward balance is in favour of private and less liquid markets. You could get hurt if you believe that your public assets are actually liquid. It also depends on the size of your fund. Large investors might be in trouble. It’s like dinosaurs versus small mammals – the latter species will prevail.

Fondo Pensione IBM
Italy
Renato Bottani, CIO

• Location: Milan
• Assets: €619m
• IBM’s Italian pension fund

Our scheme has a strong insurance component. Almost all the assets are invested in a guaranteed fund, which targets a minimum yearly return of 2%. However, the scheme allows members to choose how to allocate their pots, with some limits to equity exposure. Several members have used this freedom and have ignored the guaranteed fund altogether, investing their contributions in the equity and fixed income funds. That means that, in light of the expected turbulence in the markets, we need to re-think how the equity and fixed-income funds are managed. 

After a long and intense discussion, we decided to give more freedom to our managers. We have asked them to focus on a total-return target and to be completely independent from any benchmark. We want them to adopt an active approach. In accordance with our risk targets, the managers will be free to decide the allocation between equity and fixed income. In equity, they will be free to decide which countries, sectors and companies they can invest in, provided that the investments meet some ESG criteria. In fixed income, we have given them freedom in terms of duration and allocation between sovereign and corporate. They will also target an active allocation to country risk. All this will have to comply with the existing laws on investment limits, which were approved last year.   

Given the rapid changes in the market, we expect our managers to change the portfolio frequently. A total-return mandate should have a relatively low number of stocks and issues, which implicitly makes it more agile. We hope to reap the benefits of having a more agile portfolio, with efficient portfolio turnover. However, we should not be too disappointed if we do not see results immediately. We try not to be too fixated on the time horizon. The end result is what counts. 

The market events of the past few years led us to consider this strategy. In the past years, we were particularly disappointed by the performance of our equity portfolio. We realised that, because the equity portfolio presented risks, we needed to consider how to protect ourselves from these risks without giving up too much return potential. With this total-return approach, we will be able to react more quickly to market events, which we hope will provide protection without losing long-term return potential.

Industriens Pension
Denmark
Morten Kongshaug, portfolio manager

• Location: Copenhagen
• Assets: DKK134bn (€18bn)
• Labour market pension fund

For 2016 we have two main scenarios. The first, to which we attach a 65% probability, is expansion of global growth and global liquidity. 

In the risk scenario, with a 45% probability, the deflation we have experienced in various markets, including intermediate production, construction and commodities, will cause a recession. This would prompt serious value destruction that will drive defaults up, particularly in the energy sector. This deflationary trend would also drive the oil price down further. Output volumes could be positive, but company earnings could still come down globally, due to the strong price drops. 

The deflationary scenario is serious, as there are is no further policy easing to be done. Even if policy rates are cut by another 50 basis points, interest rates will not be able to flex. This scenario is making us hesitant to decide what to do in high-yield, emerging markets and equities in general. 

On the whole, our portfolio is not defensive, as we are still slightly overweight in risk assets. However, we are considering rotating our emerging market allocation to China. We are also looking at US small caps, as they have underperformed. With liquidity tightening in response to the Fed’s rate hike, short-end rates will rise, so we are looking to position ourselves accordingly. 

From a macroeconomic perspective, China could be seen as responsible for some of the recent weakness. The overcapacity that was created in the 2000s appears to be so significant that although we see tremendous support both by consumption and investment, the Chinese industrial sector has been in recession. The banking sector is also indicating a lot of potentially dangerous loan exposure.

In the OECD area, real incomes are okay, and this is the main driver of our main scenario. Thanks to low inflation, consumers are well off, even without nominal wage increases. That drives consumer confidence, as does the bubble-like growth of certain housing markets. However, we notice important output gaps, which underpin a situation where the job market cannot create real wage inflation. This does not support the consumption demand that is needed, and seems difficult to overcome in the short term. In short, we see a dual world economy, which is a very difficult situation. 

Interviews conducted by Carlo Svaluto Moreolo 

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