Why your biggest investment risk is ignoring your liabilities
So far, this year has been a challenging one for making investment decisions.
We have seen an upheaval in emerging markets. Credit spreads have continued to tighten, which means the returns on corporate bonds are sufficient for those pension funds that are nearly fully funded, but not enough to help close any funding gap.
It's easy to become caught up in market movements, but the real challenge is to zoom out
Political uncertainty and market volatility mean market commentators agree that the economic situation is hard to call, and whether we are out of the woods or not is still up for debate.
To add to the confusion, central banks have altered and adjusted their outlooks, and the timing of potential interest rate hikes remains largely unknown.
The greatest challenge for pension funds in all this, though, is not a changing interest rate market, tightening credit spreads, or equity market volatility. Rather it is how to make investment decisions in the face of seemingly endless complexity.
Pensions is a complex problem; it needs to be framed in the right context. The simple question that opens this article – whether bonds or equities are better – is an impossible one to answer without context.
If the question, on the other hand, includes some context – for example, ‘What is better for matching my assets to my liabilities, bonds or equities?’, then the answer becomes clear: bonds.
When we pause and zoom out, it is this context that is vital for pension funds to find their way and make clear investment decisions.
It is a framework that lays out a pension fund’s clear goals and constraints that serves to make clear which decisions need to be made, in what order, and when.
The myriad investment options are reduced to a few manageable choices. Priority is a function of context.
It’s easy to become caught up in market movements, but the real challenge is to zoom out and think about what they are trying to do. Doing so pays handsome dividends when it comes to choosing the right asset allocation.
JFK knew about courses of action, and perhaps his take can be applied to pensions: “There are risks and costs to a program of action. But they are far less than the long-range risks and costs of comfortable inaction.”
So, where should pension funds be investing their money? It sounds like an impossible question. Turns out, it’s not. The biggest risk facing pension funds is therefore a lack of context for deciding what’s better, bonds or equities.
Rob Gardner is co-founder and co-CEO at consultancy Redington