Predicting a predictable New Year
The orator and politician Cicero suggested that the best source of forecasts of the future are human experts drawing on science, reason and experience.
Following Cicero’s lead, this month’s Off the Record sought the opinion of pension fund managers, administrators and trustees and gave them the opportunity to speculate - anonymously - about what 2007 holds for pension funds and their managers.
What of the investment climate? Are equity markets fairly valued or could we see a repeat of the market ‘correction’ of 2000 and 2001? Global equity markets have recovered and then wobbled in 2006. What can we expect in 2007?
And what of the regulatory environment? Some financial supervisory authorities in Europe took a tough line on pension funds’ solvency and funding levels in the wake of the market correction. Since then there have been signs that they are prepared to relax the more draconian constraints on pension fund investment. Will this continue in 2007?
Finally what of political prospects? Demographic changes and the challenge of increasing longevity has forced governments to introduce programmes of reform for their increasingly costly pensions systems during 2006. How successful are these likely to be in 2007?
We wanted your views, and this time we posed a number of outcomes for 2007 and sought your opinion as to whether they would be likely to happen.
The regulators of European pension funds have rarely been out of the news particularly in the Netherlands, where they have been criticised for heavy-handedness. So we suggested that that the main challenge to pension funds in 2007 is more likely to be the attitude of the regulators rather than the behaviour of the equity markets. A slight majority (58%) of the pension fund managers, administrators and trustees who responded to our survey agree, while the rest (42%) disagree.
Hedge funds remained in the limelight in 2006, yet their performance has been patchy and there have been one or two nasty shocks, like Amaranth.
So will hedge funds lose some of their shine in 2007? A fair majority of managers (62%) think they will.
Some moves during the year, notably the decision by the Dutch multinational Philips to outsource the entire management of its pension fund, raises the question of whether this is a trend, and will an increasing number of corporate pension funds in Europe outsource the entire management of their pension schemes to asset managers or insurers in 2007? The affirmative view gains fairly strong support, with two thirds (67%) of respondents in agreement.
2006 saw the first year’s operation of the Pension Protection Fund. Will more European countries follow the UK’s example and consider setting up pension protection funds in 2007 to protect the members of failed pension funds? Opinion is evenly divided here with a slight majority (54%) agreeing that more of such funds are likely to be established.
One feature of the pension fund scene in 2006, particularly in the UK, has been the lemming-like rush out of defined benefit (DB) schemes into defined contribution (DC ) schemes as employers attempt to off-load investment and longevity risk on to their employees. Is this likely to continue in the New Year?
Opinion here is unanimous. All agree that the number of DB plans in Europe will continue to decline in 2007, and the number of DC schemes will continue to rise.
As far as investment trends are concerned, equities are expected to retain their importance in pension fund portfolios next year. Only a minority of managers (33%) believe that fixed income securities rather than equities, will be the most important part of a pension fund portfolios in 2007.
Yet expectations of likely returns from equities in 2007 are modest. A large majority (83%) agree that returns from equities will continue to be in single digits in 2007. Some point out that some European countries, such as France, have experienced double digit returns and see no reason why this should not continue.
The pursuit of alpha, the excess returns produced by manager skill, has been the investment leitmotiv of 2006. Yet now investment managers, particularly those advocating core satellite strategies, are emphasising the importance of beta or market returns. Two thirds (66%) agree that the capture of beta will become as important, if not more important, than the search for alpha in 2007.
Another big idea of 2006 has been liability driven investment (LDI). Some pension fund managers have suggested that LDI is nothing but an expensive fad, a fancy that will pass. Yet this opinion is not shared by most of our respondents.
Only a minority (33%) think that pension funds’ interest in LDI will diminish in 2007. Clearly hedging a pension fund’s liabilities against interest rate and inflation risk is seen as worthwhile. Longevity risk, however, perhaps because it cannot be hedged, is seen as less significant. Opinion is almost evenly divided on whether longevity risk will be the greatest risk that pension funds face in 2007, with only a slight majority (52%) agreeing.
Some predictions about the investment community are fairly predictable. A majority of managers (79%) agree that international asset managers will continue to take a greater share of European pension fund mandates and that specialist asset managers will flourish at the expense of ‘balanced’ fund managers in 2007.
The United Nations initiative on responsible investment, to which asset managers and some leading European pension funds including Norway’s Government Pension Fund have signed up, seemed to signal that socially responsible investment (SRI) had moved centre stage in pension fund investment management in 2006.
So we asked whether SRI would become a mainstream rather than marginal investment strategy in 2007. This suggestion gains little support, however. Only one in four managers (25%) agree, while most (71%) disagree.
What are the prospects for pan-European pensions in 2007 now that full implementation of the IORP directive is theoretically complete? Recently Michael Atzwanger, the managing director of the Italian regional pension fund PensPlan, suggested that the IORP directive will not lead to a proliferation of pan-European pension funds but rather induce funds to take a limited cross-border approach.
This view is supported by a survey of multinational companies by Aegon in December, which found that 74% of those interviewed would prefer to design and
implement their own integrated cross-border corporate pension systems rather than waiting for EU-wide pension legislation to be implemented.
We therefore asked whether the popularity of cross border pensions will grow in 2007 but pan-European pensions will remain an idea rather than a reality. A considerable majority (92%) agree with this analysis.
Now that the dust has settled from large scale corporate scandals, notably Enron in 2001 and Parmalat in 2004, we wondered whether any further scandals
could be expected in 2007. Here there is some optimism. Two thirds of our respondents (67%) feel further scandals are unlikely - although, as one pension fund manager comments dryly: “I don’t have any insider knowledge.”
Scandals apart, pensions look set to stay in the news. Three quarters of our respondents (75%) expect pension funds to continue to make headlines in 2007.
While pension reform continues to be cited as an urgent priority by European politicians and policy makers, little has been achieved so far. We asked whether pension reform in Europe in 2007 will continue to be a case of ‘too little, too late’. Depressingly, a majority (79%) agree with this view.
Little help can be expected from the corporate sector. More than half of pension fund managers (58%) expect the number of occupational pension plans to fall in 2007.
Yet occupational pensions may not be so important in the future. Most of our respondents (75%) feel that people will find alternatives to pensions as a form of saving for retirement in 2007 for example investing in housing.
So overall, readers of IPE adopt a trend-following, momentum strategy in their predictions for 2007 - more of the same. The next 12 months will show whether this is the right strategy.