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Low interest rates push pension funds to real assets

'Financial repression' after the global financial crisis has created an environment of low yield and has changed investor patterns with a long-lasting effect on pension funds, says Create-Research.

Risk is becoming personalized and individuals are becoming more obliged to “bear the brunt of all risks in retirement planning”, according to a survey published on Monday by Create-Research and commissioned by Principal Global Investors.  As a result, retirees are looking for safer retirement solutions over outperforming products, states Create's fifth annual report entitled Investing in a Debt-Fuelled World.

After economic upheaval in 2008 and the subsequent disaster management of policymakers worldwide through austerity, ultra-low interest rates and rising inflation, some economies have been pulled back from the edge of economic catastrophe.

However, according to the report, this period of “financial repression” characterised by low yieldsand unprecedented volatility has also created an uneasy environment for investors and retirees thanks to funding shortfalls for pension funds. As a result, there has been a shift towards real asset investments as pension plans look to diversify away from inflation-linked bonds.

Some 43% of pension plans are now invested in real assets compared with only 5% 10 years ago. These real assets include include Treasury Inflation-Protected Securities, commodities, real estate investment trusts (REITs), infrastructure and floating rate notes.

“Over the next decade, the fall-out from repeated rounds of unprecedented quantitative easingand the resulting financial repression will continue to decrease the number of defined benefit (DB) pension plans and drive the evolution of defined contribution products,” says Nick Lyster, CEO of Principal Global Investors Europe.

Global population ageing and higher retirement ages are also exacerbating the situation and putting further pressure on sponsors. And DB plans have become too expensive to keep up.

At the same time, investor interest has also changed focus. Twenty years ago, investors ached for high returns to meet their retirement and other needs. However, this assumption only held in the raging bull market of the 1990s.

“Two punishing bear markets since then have fed risk aversion and solutions alpha [alpha seeking] in equal measures,” states the report. As a result, personal interest and access to regular income have overtaken the need for capital gains.

Due to the changes, the asset management industry will need to adapt to follow this pattern, says Lyster, adding: “New, forward-looking products need to be developed. Innovations will be more solutions-based, with alpha being a question of exceeding clients’ needs rather than the market.”

Between 36% and 48% of respondents anticipate that retail investors will become opportunistic via ETFs, theme funds and actively managed funds. On the asset-allocation side, between 50% and 65% of respondents anticipate retail investors to pursue funds with an income focus, active funds, indexed funds and capital protection funds.

Baby boomers will own close to 75% of retail assets in the next five years and, forced to shoulder their own retirement risk, will radically change the global investment strategy, explains the report. “Against this backdrop, this year’s report identifies a new lens for asset managers through which to view investment strategy returns,” says Lyster.

Pension funds will need to be reformed to mitigate the personal risk that some retirees might not be able to manoeuvre themselves out of, says Lyster, adding that the US-style target-date retirement funds are an interesting model to follow, as is the new National Employment Savings Trust in the UK.

More than 700 asset managers, pension plans, pension consultants, fund distributors and fund administrators from 29 countries participated in the survey, with total assets under management of $27.4 trillion. The survey was followed-up with 100 interviews with senior executives from a cross-section of survey respondents.


What factors are likely to constrain the adoption of the positive features of DB plans into DC plans worldwide and what actions can asset managers take to minimise them?


Source: Principal Global Investors/Create-Reserach Survey 2013

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