Talking Head: The Lancashire and London Pensions Partnership’s Michael O’Higgins says in the face of increasing liabilities, it is even more important to get the balance right between security and returns.
Think back 10 years and financial markets were very different, being comparatively benign and untroubled, only punctuated by the occasional crisis.
Fast-forward to today and there is quite a change: crisis in one form or another seems to be the default state, with only the occasional lacuna of calm in-between – and then only if we’re lucky.
This level of volatility means that, even more than before, pension funds need to think long term. They need to seek liability-matching returns and therefore look towards alternatives and illiquids.
Balancing the security of a lower income against the risk or volatility of a potentially higher one is a tough trade-off, and is one of the most difficult elements of pensions policy to get right
However, there are trade-offs: how do you balance liquidity versus locked-in returns, volatility versus slow but steady, and shifting asset class selection over time?
'Reckless prudence'
Balancing the security of a lower income against the risk or volatility of a potentially higher one is a tough trade-off, and is one of the most difficult elements of pensions policy to get right.
All too often, people are guilty of what I call reckless prudence – being so afraid of risk that returns are avoided. This is a catastrophic situation for pension funds, which may see assets staying put while liabilities spiral.
This particular trade-off becomes a sharper question in the context of demographic change, as the proportion of people of working age to retirees becomes ever smaller.
Consumption and saving
According to the UN, the number of people aged 16 to 64 in the developed world peaked in 2010 and is now falling, while the number of people aged 60 and over will more than double from 841m in 2013 to 2bn by 2050.
We should not make the presumption that it is all about transferring consumption power from the working age to the elderly.
What demographics point to is the need for more of us to balance consumption and saving, so that in our old age we are not dependent only on intergenerational consumption transfers, but have also the ability to use our own deferred consumption, our capital savings, to support ourselves.
This underlying message of supporting ourselves long into the future is often lost when discussing pensions – which is, ultimately, a large part of what they are for.
Michael O’Higgins is chairman of the Lancashire and London Pensions Partnership
