And now for the weather…

But investment consultants sometimes play games of their own - ‘And Now For The Weather’ is one much-loved game and is played by those who purport to predict financial markets accurately over the next year or two, or an even longer horizon.

Unsurprisingly, just like those who attempt to predict the actual weather two years in advance, players of ANFTW tend not to be particularly accurate.

Even if I am a highly trained meteorologist, my long-range weather forecast is, at best, merely a guess, and it is utterly pointless for you to rely on it. 

And yet, for the past decade, some pension schemes have based their entire risk management strategy on equally dubious long-term market forecasts – with catastrophic consequences.

They have bet on a systemic shift in interest rates and inflation expectations. I have lost count of the number of underfunded pension schemes whose current plight can be explained almost entirely in terms of the misplaced anticipation that yields would rise and liabilities would fall. That, by now, the rain clouds would be replaced by bright blue skies.

For the past decade, some pension schemes have based their entire risk management strategy on equally dubious long-term market forecasts – with catastrophic consequences

The harder the rain fell, the more they doggedly clung to the doctrine of inevitable rising real yields, spurred on by various pundits playing round after round of ANFTW.

Forecasting failure

The rules are straightforward to grasp. In a classic, high-stakes game of ANFTW, a professional player delivers a lengthy preamble concerning the suspect nature of financial markets.

He then confidently attempts to predict the future, saying something along these lines:

“It is plainly ludicrous that the real yield is down at this level. It must inevitably rise from here; indeed, we predict an increase in 2017.

“The mean reverting nature of interest rates and long-term inflation expectations, allied with sustained quantitative easing and an expected strengthening of the economy is highly likely to lead to an increase in real yields of 1 per cent.

“Notwithstanding our actual experience over the past decade, deteriorating funding levels and increasing risk, it makes perfect sense to wait for yields to rise, which they surely will in the next year or two.”

At this point, the player might reasonably be expected to add:

“This is, of course, an ultra long-range weather forecast. It is merely my personal opinion and, instead of acting on it, you should urgently apply basic risk management principles to managing your pension scheme.”

But that, as many pension schemes have discovered to their cost, is not how this particular game is played.

Dawid Konotey-Ahulu is co-CEO at Redington