Reacting to the impossible
Reacting to the attacks in America and predicting the long-term effects is an almost impossible task for pension funds. Given falling markets and the uncertainty surrounding the extent of retaliation, it appears they are rather restricted in their ability to limit the consequences. Many obvious sectors – airlines, insurance and tourism, for example – have already been sold heavily but, other than small tactical adjustment, how do funds react to crises and do they have contingency plans for emergencies?
Pension fund managers are taking a level-headed approach and, according to many of them, the priority is to look at the long-term consequences rather than to make adjustments at the micro level. Immediate operational issues – such as clearing and settlement – need to be monitored but one professional who has run US pension schemes says the top investment managers have tried-and-tested disaster recovery plans. This is borne out by the astonishing speed at which companies have moved to new offices and resumed business.
Extensive selling has added to the pressure already present before the attacks. “You do hear of clients and individuals moving out of the markets and moving to cash at a time when it’s probably exactly the wrong time to do that,” says the same professional. Reassuringly though, the majority of schemes are genuinely long-term investors and strategic asset allocations have by their very nature a long horizon. Trustees spend months with actuaries and consultants designing strategic asset allocations that typically have a five-year outlook. By going in and making tactical plays right now, you run the risk of being out of the market when they come back and correct, he says.
In practice many funds and investment managers avoid extensive market timing as it is so difficult to guess the behaviour of the market. Obviously this holds truer the more extreme the cause of the volatility. “It’s almost impossible to get the timing right. Certainly, people will be reviewing after the event whether anything fundamental has changed,” he says.
Peter Bowers, European partner at William M Mercer, agrees, saying a knee-jerk reassessment of the equity and fixed income balance is unlikely in the immediate aftermath. “Because pension fund investment is still long term people will wait and see what happens to the market and then take a view. They are not going to be swayed by short-term moves in the market.”
What it is likely to do is to lead to a reassessment of strategy. Most pensions managers agree there will be increased market volatility and this obviously exacerbates risk. In addition, if markets stay down for a long time, the consequences are likely to be more severe for equities rather than for fixed income.
In addition, there is the question of matching assets with liabilities. Bowers says the move to match assets and liabilities closer is likely to be exaggerated by any sharp fluctuations in equity markets. Bowers adds that people will be that much more conscious of risk and that the events will perhaps lead to a reassessment of their strategic allocations to equities.
At ABP, Europe’s largest pension fund, there was a marginal move to overweight European stocks at the expense of US equities. But again, the fund stresses the long-term nature of its investments. In addition, extreme circumstances often render normal analysis redundant. “You have to be very careful in simply using risk measurement systems that are based on normal distributions and long term correlation matrices in order to predict the current extreme situations,” says Jan Straatman, CIO of global equities at ABP pension fund.
Investment managers and pension managers have praised for the reaction of the monetary authorities. The decision by the Fed and the European central bank to cut interest rates and the ability for corporates to go back into the market and buy back stocks has produced an environment that’s as supportive to the market as is possible.
The same professional says that were he back running a US scheme, his inclination would be to stick the course and ride out the storm. “If you look back at the major market events, within three or four months of these individual events people typically find themselves back where they once were.”