Proactive investment strategies are key for protecting schemes in times of high volatility, experts have said, as ripples from the Chinese market rout reinforce the need for scheme triggers.
Volatility has increased to the highest levels seen since 2011 as capital markets react to fears of a slowdown of the Chinese economy. The FTSE 100 dropped by roughly 5 per cent on Monday before recovering slightly.
The Vix – an index used to measure investor sentiment around market volatility, also known as the 'fear gauge' – rose to a high of 53 on Monday from a high of around just 14 a week before.
What a difference a week makes…
William Parry, investment consultant at Buck Consultants, said events reinforced the importance of preparing pension fund investment strategies for different scenarios and not deviating from plans.
Since 2009 we’ve had a hell of an equity market run, but funding levels haven’t improved much because of bond yields
David Vickers, Russell Investments
“The important thing is making sure you’re never in a position to have to react that quickly,” he said, adding that even when seasoned investors are faced with large market movements “the temptation is to pick up the phone”.
Pre-set triggers can allow schemes to move quickly but not rashly when conditions change, Parry said.
“Implementing [an agreed trigger] quickly is not the same as reacting badly,” he said.
Despite large movements in capital markets, Parry said the events of 'Black Monday' were to a certain extent part of an anticipated market correction in response to slowing growth in China.
“Equities have been softening over the summer and gilt yields have started to move against trustees as well," he said. "The gains people were hoping to lock in this year haven’t transpired. [Black Monday] was a continuation of a longer-term theme.”
Challenging environment
David Vickers, fund manager at asset manager Russell Investments, said schemes that were unhedged or over-reliant on equities for their returns had been “kicked especially hard” as markets fell.
However, he added gilt yields were also putting pressure on scheme funding.
This is especially dangerous for schemes as poor equity performance can obstruct the potential for growth while increasingly low yields push up liabilities.
Vickers said: “Since 2009 we’ve had a hell of an equity market run, but funding levels haven’t improved much because of bond yields.”
He said using an investment process with clients that takes into account valuations, the economic cycle and market sentiment when evaluating investments reduces the potential for emotional decision-making.
Speaking about Black Monday, Vickers said: “Every fibre of my being was telling me to sell the market… Had we done that we would have missed the [rally].”
John Walbaum, partner at consultancy Hymans Robertson, said schemes should use strategies that take into account growth, income and protection.
The need for income is more important, he added, as defined benefit schemes increasingly become cash flow negative, as in many cases “in a long-term run-off, they are not yet anywhere near the price of benefits they’re going to pay”.
“The focus on income now is becoming more and more acute."
