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Monday 30th November 2015
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updated 5.50pm, Wednesday 29th April 2020
The recent headline of a news story in The Actuary is a dangerous and highly unfortunate message to propagate.
The recent headline of a news story in The Actuary: Pensions industry is not taking enough investment risk, say actuaries ( bit.ly/1VWkNnG) is a dangerous and highly unfortunate message to propagate. Ashok Gupta is quoted as saying that over the past 20 years companies have massively reduced their risk-bearing away from equities to bonds, leading to problems.
The article, and particularly the headline, is misleading, and key issues are overlooked.
? Over the past 20 years, companies and trustees have indeed massively reduced risk in pension schemes. But they were still taking massive risks, and it was the taking of these risks that led to the problems and the pension scheme deficits we face today. The best-performing asset for pension schemes over the past 20 years has, in fact, also been the least-risk asset. A typical matching bond portfolio would have massively outperformed a typical equity portfolio over the past 20 years.
? It makes no economic sense for companies to issue bond-like promises to employees (in the form of a promise to pay a future pension) and then seek to invest in risky assets to deliver on those promises (accepting the point that the original 'promises' were only turned into absolute promises by government legislation) - in the same way that it makes no sense for a manufacturing company to issue a bond in the market and then use the proceeds of that bond to invest in a portfolio of risky assets, even if those risky assets are expected to give a return in excess of the cost of servicing the bond. The obvious truth of this was amply shown by Exley, Mehta and Smith nearly 20 years ago.
? Short-term volatilities do matter. A primary purpose of a pension scheme is to provide security for members in the event that the sponsor company is unwilling, or unable, to continue to deliver on its pension scheme promises.
Sure, if we never had to worry about companies going bust, we would not need to be so concerned about deficits and short-term volatilities. But companies do go bust, and, sadly, there is a correlation between the insolvency of companies and the size of the deficit in their pension scheme.
The article, and particularly the headline, is misleading, and key issues are overlooked.
? Over the past 20 years, companies and trustees have indeed massively reduced risk in pension schemes. But they were still taking massive risks, and it was the taking of these risks that led to the problems and the pension scheme deficits we face today. The best-performing asset for pension schemes over the past 20 years has, in fact, also been the least-risk asset. A typical matching bond portfolio would have massively outperformed a typical equity portfolio over the past 20 years.
? It makes no economic sense for companies to issue bond-like promises to employees (in the form of a promise to pay a future pension) and then seek to invest in risky assets to deliver on those promises (accepting the point that the original 'promises' were only turned into absolute promises by government legislation) - in the same way that it makes no sense for a manufacturing company to issue a bond in the market and then use the proceeds of that bond to invest in a portfolio of risky assets, even if those risky assets are expected to give a return in excess of the cost of servicing the bond. The obvious truth of this was amply shown by Exley, Mehta and Smith nearly 20 years ago.
? Short-term volatilities do matter. A primary purpose of a pension scheme is to provide security for members in the event that the sponsor company is unwilling, or unable, to continue to deliver on its pension scheme promises.
Sure, if we never had to worry about companies going bust, we would not need to be so concerned about deficits and short-term volatilities. But companies do go bust, and, sadly, there is a correlation between the insolvency of companies and the size of the deficit in their pension scheme.
I hope that this sort of misleading thinking (and headline grabbing) is not encouraged.
Charles Cowling
4 November 2015
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