Tuesday, January 31, 2012

Record High Pension Assets Hit by Liabilities?

Towers Watson just came out with a report, Global pension fund assets hit record high in 2011:

Global institutional pension fund assets in the 13 major markets grew by 4% during 2011 to reach a new high of US$28 trillion, up from US$26 trillion in 2010 according to Towers Watson’s Global Pension Assets Study released today. The growth is the continuation of a trend which started in 2009 when assets grew 17%, and in sharp contrast to a 21% fall during 2008 which took assets back to 2006 levels. Global pension fund assets have now grown at over 6% on average per annum (in USD) since 2001, when they were valued at US$15 trillion.

The study reveals that, despite the growth in assets, pension fund balance sheets1 weakened globally during 2011, with the ratio of global assets to liabilities well down from its peak achieved in 1999. According to the study, pension assets now amount to 72% of global GDP, which while lower than in 2010 (76%) is substantially higher than the 61% recorded in 2008.

Carl Hess, global head of investment at Towers Watson, said: “In case investors needed any reminding, the last six months of 2011 have driven home the need to have investment strategies that are flexible and adaptable and which contain a broader view of risk. This approach makes greater allowance for extreme events, which are occurring more frequently, while accommodating the softer elements of risk, such as credit and liquidity. The past few years have focused attention on the multi-faceted nature of risk within our increasingly precarious financial systems. At the same time risk management processes have evolved somewhat to factor in more qualitative measures. However, there is still some way to go before the appropriate measurement and management of risk is firmly embedded in the governance structures of most pension funds.

Other highlights from the report include:

Global asset data for the P13 in 2011

  • The ten-year average growth rate of global pension assets (in local currency) is over 6%.
  • The US, Japan and the UK remain the largest pension markets in the world, accounting for 59%, 12% and 9% respectively of total pension fund assets globally.
  • All markets, except Japan, saw growth in pension assets in 2011 (measured in local currency), and all markets in the study, except Japan, have positive ten-year compound annual growth rate (CAGR) figures.
  • In terms of ten-year CAGR figures (in local currency terms), Brazil has the highest growth of 14% followed by South Africa (13%), Hong Kong (10%) and Australia (9%). The lowest are Japan
    (-1%), France (1%), Switzerland (4%) and Ireland (4%).
  • Ten-year figures show the UK has grown its pension assets the most as a proportion of GDP (by 30% to be 101% of GDP ), followed by the Netherlands (up 23% to 133% of GDP), Australia (up 17% to 89% of GDP), Hong Kong (up 15% to 34% of GDP) and the US (by 12% to 107% of GDP). During this time Japan's ratio of pension assets to GDP has fallen by 1% to 55% of GDP.

Asset Allocation for the P7

  • Bond allocations for the P7 markets have decreased by 3% in aggregate during the past 16 years (40% to 37%). Allocations to equities have fallen by 8% (to 41%) during the same period, although much of this fall (7%) occurred in 2011.
  • Equity allocations in the UK have fallen from 67% in 2001 to 45% in 2011 (falling 10% in 2011 alone); similarly in the US allocations have fallen from 65% to 44% during the same period. Australia maintains the highest allocation to equities at 50%, while Japan has the highest allocation to bonds of 59%.
  • Allocations to other (alternative) assets, especially real estate and to a lesser extent hedge funds, private equity and commodities, for the P7 markets have grown from 5% to 20% since 1995.
  • In the past decade most countries have increased their exposure to alternative assets with the US increasing them the most (from 5% to 25%), followed by Switzerland (9% to 28%), Netherlands (1% to 14%), Australia (14% to 24%) and Canada (10% to 20%).

Carl Hess said: “The volatility in markets and the heightened risk awareness associated with possible sovereign defaults continues to make asset allocation incredibly challenging as companies and trustees balance such priorities as long-term de-risking, short-term market opportunities, rebalancing or maintaining a strategic asset allocation mix. These are already complex decisions - which are increasingly being delegated to specialists such as fiduciary managers - without adding numerous competing considerations, such as contributions from already stretched sponsors, contingent funding arrangements, hedging strategies and pension insurance buy-ins and buy-outs, not to mention changes to benefits structures including fund closures.”

Defined Benefit (DB) and Defined Contribution (DC) for the P7

  • During the ten-year period from 2001 to 2011, the CAGR of DC assets was 8% against a rate of 5% for DB assets.
  • DC assets now comprise 43% of global pension assets compared with 41% in 2005 and 38% in 2001.
  • Australia has the highest proportion of DC to DB pension assets, 81% : 19%.
  • The markets that have a larger proportion of DC assets than DB assets are the US, Australia and Switzerland while Japan and Canada are close to 100% DB. The Netherlands, historically only DB, is now showing signs of a shift towards DC, having grown these assets by 6% in the past five years to reach 7% of total assets.

Carl Hess said: “If institutions are finding it tough to invest, the growing number of individuals making their own investment through DC vehicles are facing a real challenge to preserve wealth, let alone augmenting their contributions via net-of-fee returns. Getting the default investment option right continues to be a priority for companies and trustees, while various governments battle the rising demographic tide by auto-enrolling or otherwise encouraging their citizens into sustainable vehicles for cost-effective retirement saving . At the same time companies and trustees are trying to balance the affordability of their plans with employee demands for suitable alternatives to retail savings vehicles.”

Public vs. private sector pensions in 2011

  • 65% of pension assets of the P7 group are held by the private sector and 35% by the public sector.
  • In the UK and Australia the private sector holds more than 80% of pension assets with 88% and 85% of total assets respectively.
  • Canada and Japan are the only two countries where the public sector hold more pension assets that the private sector, holding 61% and 71% of total assets respectively.

Notes to editors

  • The P13 refers to the 13 largest pension markets included in the study which are Australia, Canada, Brazil, France, Germany, Hong Kong, Ireland, Japan, Netherlands, South Africa, Switzerland, the UK and the US. The P13 accounts for more than 85% of global pension assets.
  • The P7 refers to the 7 largest pension markets (over 95% of total assets in the study) and excludes Brazil, Germany, France, Ireland, Hong Kong and South Africa.
  • All figures are rounded and 2011 figures are estimates.
  • All dates refer to the calendar end of that year.

1Measured by asset values over liability values using sovereign bond yields to discount liabilities.

aiCIO also reports, Record High Pension Assets Hit by Rising Liabilities:

Global pension assets hit a record high at the end of last year, but burgeoning liabilities meant funding ratios were in a worse state than 12 months earlier, a survey has shown.

Assets held in defined benefit and contribution schemes at the end of 2011 hit $27.5 trillion, according to investment consulting firm Towers Watson.

This figure showed a 3.9% increase in the asset level over the 12 months, but this was much lower than the 10.9% rise over 2010. All figures were stated in US dollar terms.

However, lower interest rates and changes to other accounting measures around the world’s major economies meant liabilities also hit record highs compared to a benchmark date at the end of 1998, Towers Watson said.

Using this measure, liabilities were 107.3% of their 1998 totals, whereas assets had only grown 54% from this point.

This shift meant global pension fund balance sheets worsened in 2011, losing 4.3% in the asset-liability indicator, despite the growth in assets.

Chris Ford, Head of Investment in Europe, Middle East and Africa at Towers Watson, said: "In case investors needed any reminding, the last six months of 2011 have driven home the need to have investment strategies that are flexible and adaptable and which contain a broader view of risk. This approach makes greater allowance for extreme events, which are occurring more frequently, while accommodating the softer elements of risk, such as credit and liquidity.”

Across the 13 countries counted in the survey, which have the largest pension fund assets worldwide, the allocation to fixed-income investments rose, and the percentage held in equities fell over the year, indicating investors were moving away from risky assets.

The largest shift towards bonds was seen in the United Kingdom, where 15 percentage points worth of assets were moved into fixed-income investments since 2006. A seven percentage point shift to alternative assets made up the rest of a 19 percentage point reduction of equity holdings.

Japan and the Netherlands - both relatively risk-averse investing nations – moved the next largest amount of assets into fixed income. They moved 13 and 14 percentage points of assets into bonds and other related securities over the five years to the end of 2011, cutting equity exposure by over 10 percentage points.

Investors in the United States, which holds 80% of pension assets within its borders, withdrew 16 percentage points from equities over the last five years, preferring split these assets between alternatives and fixed-income securities.

Ford said: "The volatility in markets and the heightened risk awareness associated with possible sovereign defaults continues to make asset allocation incredibly challenging as companies and trustees balance such priorities as long-term de-risking, short-term market opportunities, rebalancing or maintaining a strategic asset allocation mix.”

The largest surge in assets came from some developing economies, Towers Watson said. Brazil and South Africa saw pension assets climb by over 16% in 2011. Australia, which offers mainly defined contribution schemes, saw assets rise by 17% over the same period, in US dollar terms.

Over the past decade, however, Brazil has seen the largest asset growth with an upsurge of 14.3%. South Africa and Hong Kong followed slightly behind with 12.5% and 10.3% respectively.

You can read the Towers Watson Global Pension Assets Study 2012 by clicking here. When it comes to pensions, its all about matching assets to liabilities. And with the growth rate of liabilities outpacing that of assets, it's not surprising that global pension plans are in the hole. But keep in mind that underfunded pensions can get back to healthier status if they take the necessary measures to restore funding.

Unfortunately, here is where things get tricky. If we are heading toward a long-term debt deflationary cycle, then pensions are better off de-risking and shifting more assets into bonds, even at historic low interest rates, and focus more on generating alpha internally or through external managers.

However, if we are on the precipice of major inflation, then pensions should reduce their allocation to bonds, pile into risk assets, including inflation-sensitive assets, and allow the rise in bond yields to 'fix' their funded status gradually over time.

I can make the case for both deflation and stagflation. I am more worried about deflation because we just entered a period of massive deleveraging/austerity which will mute growth in the developed world. Having said this, bankers and policymakers will do whatever it takes to fight debt deflation, injecting trillions into the global financial system. All that liquidity will find its way somewhere and will eventually stoke inflationary expectations, but in a low growth environment (stagflation).

Add to this all the trillions invested in hedge funds and you get a great environment for traders to keep trading and profiting from the volatility in markets. This, in a nutshell, is what I foresee for the decade ahead. This will prove to be an extremely challenging environment for pensions and all long-term investors.

Below, Fredrik Nerbrand, global head of asset allocation at HSBC Holdings Plc, talks about investment strategy, adding risk, and the potential impact of higher oil prices on the global economy. He speaks with Owen Thomas on Bloomberg Television's "On the Move."

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