Tuesday, 16 December 2008

Pension funds and equities

I had a conversation last week that was really a sign of the times. A couple of sensible industry people were seriously talking about whether pension funds need to rethink their approach to investing in equities. It's not surprising, I guess, given the events of the past few years. After the post dot-com bubble burst we've seen another surge upwards fizzle out and reverse.

This must be knackering pension funds right now, having only just clawed their way back to better funded position. Most pension funds still put the bulk of their assets in equities, and this is a global downturn, so they can't escape. They must be under a lot of pressure in terms of funding right now. I can only imagine that more nasty benefit reductions are in line for lots of pension scheme members.

People will retort that equities will outperform over the long term, as they ought. But let's be clear that market volatility in the short-term has been a major contributory factor in the death of DB in the UK. Once employers properly experienced the downside investment risk of DB (having enjoyed the contributions holidays and refunds of surplus) they didn't take long to get rid. Whatever arguments we might advance about the long-term liabilities of pension funds, finance directors facing volatile costs aren't going to wait around. In effect in pension funds politics the long term hasn't mattered.

And maybe that is understandable. One of the things this crisis has really brought home to me, as it has featured a second slump in equities within a short period of time, is just how volatile financial markets really are. For all the guff in the City about the ability to forecast trends for sectors or companies the reality is an unknowable future. Taking a punt on equities a lot more risky than those folks trying to talk to you about 'alpha' usually suggest. We may have a much weaker grasp on the true nature of risk in financial markets than we realise, as this bloke argues.

PS. Some people on the Left are looking at this.


CharlieMcMenamin said...

Yes: the sociologists, of all people, have cottoned onto this - here's a paper which argues that the major risk management techniques used in financial markets don't really work that well,but have been adopted because they provides a convenient lingua franca through which different interests can purport to understand each other http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1031745

& here's one from the same stable which says the very same techniques don't work at all...at least not in Poland http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1031850&rec=1&srcabs=1031745

Nick Drew said...

forecasting is for fools, as Galbraith, Keynes and Drucker all say in more elegant (but equally blunt) ways

I will make my 2009 predictions with the best of them (am quite pleased with some of my '08 efforts), and may even invest on the back of some of them; but this has nothing to do with forecasting

Tom P said...

Cheers for the links Charlie, will have a butchers.

Hola Nick

Would be interesting to have a look back at predictions for the level of the FTSE. I bet no-one thought it would look this bad.

Will keep an eye out for your crystal ball gazing!

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