Amundi-CREATE Research has offered its independent assessment on challenges now faced by the world’s pension funds, given the policies of central banks.
The subject is of great significance to alternative investments managers who represent the aggressive end of many a pension fund’s portfolio. The gist of the report is that it has become more necessary over time for pension funds to become aggressive, because low rates (too low for funds to meet their obligations) for conservative investments are now “expected to remain embedded in the global economy.”
There has been a decade, now, during which a “deflationary mindset” has dominated central banks, and the resulting monetary stimulus policies have, Amundi says, created “a number of unintended consequences for [investors], such as lower yields for longer [maturities] and inflated asset prices.” Pension funds have had to change their asset allocation models as a consequence of the long era of quantitative easing.
Amin Rajan, the project leader of CREATE Research, says that the surveys on which the report is based were initiated in 2014, and involved 153 pension plans and 38 pension consultants. Rajan thanks all the participants for helping him understand the disconnect that the situation has created between the real economy and the financial world.
The report acknowledges that QE served a valuable purpose. It stabilized financial markets after the crises of 2007-2008, and kick-started growth starting in 2009.
On the negative side, though, the report says that QE has allowed an inexorable increase in debt, has disconnected asset prices from real value, and has allowed governments to “backslide on essential growth-friendly supply-side reforms.”
A historically high level of global debt has meanwhile been keeping zombie borrowers afloat.
Going Cold Turkey Can Be Tricky
Can the central banks simply say, “All right, QE has served and arguably outlived its purpose. Let us return to a pre-crisis notion of normal levels of credit and interest rates”? Well, that may be tricky. The central banks in Japan first and later in both Europe and the United States have tried to say something of the sort and have come under intense pressure as a consequence. One obvious problem is that that rate rises will sink those zombie borrowers, generating unemployment and downward pressure on prices.
“When asked about QE’s future, the majority of our survey respondents think that it will be very hard to unravel QE without huge market volatility—so deeply is it now entrenched in investor psyche after 10 years of ultra-loose money.”
So what are the present aims of pension funds? They want to “conserve capital, manage liquidity, plan for mean reversion and reduce mark-to-market volatility.” This involves a flight to quality and longer holding periods on assets, both public and private. As to the flight to quality, the report observes that although global equities used to be perceived by pension fund managers as risky, that has now become a safe high-quality choice in the face of mispriced credit and low sovereign yields.
Pension funds also see emerging market assets as an opportune vehicle for riding a secular wave in the face of secular stagnation.
Pension plans themselves list global equities as their favorite asset class while QE continues, and infrastructure as their second favorite. Pension consultants list infrastructure as number one, alternative credit as number two, and global equities as three.
Worried About MMT
The report also expresses concern, on behalf of pension fund managers, over the current political/intellectual fad for “modern monetary theory.” It characterizes MMT as a view that would justify massive budget deficits and money creation, on the grounds that since earlier rounds of quantitative easing help the rich get richer, there should be new rounds of QE, even more aggressive, that will “help the poor become less poor, in an age defined by raging inequalities.”
One interviewer summed up this concern, saying that the “global debt python will continue to constrict growth as its service cost climbs.”
Pension funds need to increase their funding levels. They’ve hit on two ways of doing this: one-off cash injections from their sponsors on the one hand and portfolio reallocation on the other. As noted above, the portfolio approach favors emerging markets, illiquidity, illiquid projects such as infrastructure, and global equities.