How does the low oil price affect pension funds and what can they do in response?

The oil price is just one of many factors contributing to market volatility. Unfortunately, investors can find plenty to worry about: the Chinese economy, the US election, Venezuela’s potential default, Brexit – to name just a few.

Pension liabilities are also likely to be volatile. Key financial factors such as gilt yields and inflation will respond to investor behaviour and the actions of governments, the IMF and central banks. Pension schemes and their trustees are faced with an extremely complex and unpredictable environment.

If trustees are invested in passive equities they will hold stock in sectors that are hit hard by oil price falls or sustained low oil prices.

But it is not just equity investors that stand to lose out. Holders of emerging market debt could also suffer if any of the distressed oil-producing nations default on their debt.

On the other hand, trustees will also be invested in many companies and markets that might benefit from the low price of oil. The upside may take some time to feed through as big energy users often hedge their exposures.

At the same time, lower oil and general energy prices can lead to lower costs and lower inflation, while also increasing consumer spending power. These potentially contradictory factors will in turn feed through into... well, it is anyone's guess.

Tactical investment

When markets fall, there can be the temptation to try and use the situation to your advantage. Trustees should however recognise that making astute tactical investment decisions requires an accurate and comprehensive prediction of the future.

As we know, this is never easy. I would assert that for most trustees it is virtually impossible.

To back up this assertion I would ask: could anyone have predicted the course of the past 10 years? The realistic answer is, of course, no. So what makes anyone think they can predict the course of the next three, five or 10 years?

This is not to say there is nothing trustees can do. Let us for a moment consider a few lessons from history. It is interesting to consider the question: what might trustees reasonably have done back in 2006 that would have held them in good stead for the next decade?

In my opinion, this would not have been about appointing new fund managers or taking a more tactical approach to investing. Instead, I would highlight three strategic actions that, had trustees taken, might each have had a positive effect:

• Hedged some of their unrewarded risks
• Diversified their growth assets
• Adopted a more risk-based approach to investing

This is not simply written with the benefit of hindsight. The fact is that many trustees adopted some or all of these strategies many years ago, and they have helped see pension schemes through some extraordinary times.

Hedging and diversification

While hedging options have expanded over recent years, many trustees have for some time hedged all or some of their interest rate risk. Initially this might have primarily been through holding a good matching bond portfolio or, for some of the earlier adopters, through a bespoke liability-driven investment solution.

Diversification is not a new theme. While diversified growth funds have captured large volumes of pension fund money over recent years, trustees have long sought downside protection through portfolio diversification.

Finally, managing the portfolio from a risk perspective is not new either. Many of the trustees who moved from active to passive management in the 2000s did so to manage risk.

My message is therefore straightforward: trustees should not let market volatility distract them from doing the simple things well. The trustee response to the oil price collapse should be calm, considered and strategic.

Jonathan Reynolds is client director at professional trustee company Capital Cranfield Trustees