An old adage claims that there are three kinds of people: those who make things happen, those who watch things happen and those who say, “What happened?” After surviving 2008, many pension fund sponsors must feel like they belong in the third group.
Regardless of asset mix or strategy, just about every pension fund has had a horrible year. Pension funds feeling the pain would include those with:
• High public market equity exposure;
• High exposure to corporate bonds;
• High utilization of hedge funds;
• Investments in complex structured products;
• High allocations to alternatives such as private equity and infrastructure;
• A lot of credit derivative products; and
• Hedging of all of their U.S. dollar exposure.
Any fund that isn’t covered by the above list may be breathing a huge sigh of relief—but if so, they are breathing it quietly. Most funds have not reported results yet, even on an interim basis. It would be interesting if Benefits Canada were to sponsor a contest for industry participants to forecast which investment approach will have the most devastating impact on funding.
Before attempting such a forecast, we have to recall that funding also depends on the liability valuation basis. Many funds may not have to update their valuations until 2010, which will buy them some time. But the results will also depend on the purpose of the valuation. Going concern valuations are usually geared off Canada bond yields (which are down) so that liability values would be up. Conversely, accounting basis valuations are geared off corporate bonds yields (which are up) so that liability values would be down.
Confused? No wonder so many industry participants are asking, “What happened?” Since most pension funds were already in a deficit position going into 2008, there are very few cocky chief investment officers or exuberant trustees for pension funds these days!
Does the pension cloud have a silver lining? Historically, market returns have been quite attractive in the years after a market meltdown. While the past is no predictor of future results, we can take away some lessons from the experience. Perhaps the pension fund industry needs to return to its roots and consider the following strategies.
1. A focus on long-term investment horizons with an emphasis on investing, not trading, and a bias for absolute, not relative, returns.
2. Smoothed valuations for both assets and liabilities to avoid being unduly affected by short-term market volatility.
3. A focus on funding risk, with a particular emphasis on the potential for downside or worst-case scenarios, while recognizing the reality that long-dated pension obligations cannot be immunized.
4. A return to traditional investment values—only doing business with trusted partners and only investing in strategies where the products, their costs and their risks are truly understood.
What happens after 2008? No one is willing to predict the timing or the shape of a future recovery. But industry participants should view this as a wake-up call to ask the right questions, hire the right managers and pursue a well-constructed investment strategy.