From the blog: Growing evidence suggests the long-term trend for real and nominal growth may be well below that of recent decades.
Not only are lower asset returns restricting pension fund growth, falling bond yields are increasing their future obligations.
Pensions have begun to accept the harsh reality of what is required to close their funding shortfalls.
Just a couple of reasons for this include: lower productivity growth and demographic trends could limit GDP, which will constrain interest rates, while structural adjustments in Europe, China and Japan could mean more modest global growth ahead.
Lower growth will inevitably result in diminished capital market returns.
In such an environment pensions are compelled to fundamentally re-examine investment policies to see if there are other levers they can pull to generate higher returns.
Not only are lower asset returns restricting pension fund growth, falling bond yields are increasing their future obligations.
Pensions have begun to accept the harsh reality of what is required to close their funding shortfalls.
They can either make higher contributions or change their investment strategy to increase returns.
For many, this will mean inevitably adding risk through the use of leverage or increasing exposure to alternatives / systematic market exposures.
Leverage can help corporate funds reach their required returns…
Looking at leverage, the average asset allocation of many corporate pension plans is too timid.
For example, adding leverage through interest rate overlays could help a corporate plan actually reduce funded status volatility without reducing expected returns.
Another option would be to allocate to strategies with built-in leverage, such as hedge funds, private equity and real estate, which should increase expected returns.
Illiquid assets are another option, which should allow investors to harvest a significant illiquidity premium.
Illiquidity premium from private investments…
In periods of market dislocation, nimble investors willing to implement such opportunistic strategies should generate excess returns.
Another lever that can be pulled to boost return is to invest in hedge fund-like ‘alternative beta’ strategies, which are comparatively low cost while also being more liquid and transparent – in many cases acting as a supplement to fixed income allocations, adding diversification without interest rate sensitivity in a rising rate environment.
As passive takes an increasing share of investor flows, this should present greater opportunities for those investors looking to alpha as a way to generate additional return.
Given we will be stuck in a world of lower asset returns for a considerable time, schemes would do well to face reality.
Anthony Gould is global head of pensions advisory and solutions at JPMorgan Asset Management
