Covid-19 is predicted to cause a sea-change for pension fund investing, mainly in the area of private markets and ESG.
Schemes are expected to seek private markets for greater portfolio resilience, and invest in ESG now that Covid-19 has made more companies realise they “need a social licence to operate”.
Meanwhile, global equities will be sought as pension funds try to plug funding gaps.
Portfolio resilience is the chief prize for schemes, with “anti-fragility” the key concern, according to Professor Amin Rajan (pictured), whose latest research has just been published.
Three quarters of schemes surveyed said they will target private markets to achieve custom-built resilience, whereas “high-quality cash flow compounders” among global equities will top the asset allocation choice for 76% of respondents looking to build antifragility into their portfolios.
The research was published by Professor Rajan’s Create-Research consultancy and asset manager Amundi. It has 158 respondents from pension funds in 17 markets managing nearly €2 trillion in assets.
Stimulus measures by governments and central banks contributed to attitudes, with many respondents expecting a volatile W-shaped or accordion-shaped recovery. Many respondents (84%) even felt it was likely that central banks would lose their independence from governments.
The vast majority expected asset returns to be lower this decade than the previous ones.
Professor Rajan said: “Assessing the macroeconomic damage of Covid-19 is akin to looking through a kaleidoscope: different images appear with each turn of the dial. However, one thing is certain: the longer the pandemic lasts, the greater the economic damage to pension plans.”
Investing is now reduced to the single imperative of “antifragility”, he said, and means liquidity and resilience will feature high in asset allocation decisions.
Over half (58%) will turn to thematic investing to increase portfolio resilience. An un-named UK pension plan highlighted demographics, focusing on health care, and urbanisation. Technology focussing on artificial intelligence, 5G networks and cloud computing were also highlighted, as was ESG: focusing on renewable energy, labour practices, and corporate governance.
The research also showed that ESG will be appreciated more for its resilience and risk-adjusted returns. The market crash in March was a “true test of whether or not ESG investing is just a bull market luxury, lacking resilience against big drawdowns”, said the professor, adding that the findings showed otherwise because 52% of respondents had ESG allocations that performed better than the rest of their portfolio and 45% the same level of performance.
Furthermore, the “long ignored middle child of ESG” - the ‘social’ factor - has come into its own as Covid-19 has exposed low wages, precarious jobs and labour exploitation in frontline occupations – especially in the retail, transport and medical industries, according to the research, which quotes another pension fund saying that “firms are becoming aware that they need a social licence to operate. The old ways are now unacceptable to their customers".
Among other findings were that since sovereign bonds are expected to make minimal total returns, risk tools will rely overly on other means. Greater scenario planning will be the preferred approach used by plans to manage risk in portfolios over the next decade (61%) whilst almost two thirds (57%) will rely primarily on liquidity management. Diversification will remain a massive cornerstone in investing – be it based on asset classes (55%) or risk factors (54%).
The survey showed that five asset classes will be favoured for income: infrastructure (58%), US investment grade bonds (44%), emerging markets investment grade bonds (41%), private debt (38%) and European investment grade bonds (36%).
Infrastructure in particular will benefit from large-scale fiscal stimulus with a special focus on renewable energy and its improving cost dynamics. One respondent added: “With its in-built resilience, infrastructure will be the biggest winner of this crisis.”
As for inflation protection, equities and infrastructure will be favoured again; commodities and real estate debt much less so with only 4% and 29% of votes, respectively.
Sovereign bonds will be favoured by a small minority (18% for US government bonds and 17% for emerging market government bonds) and only those with good funding ratios that permit a high degree of portfolio de-risking.
Pascal Blanqué, group chief investment officer at Amundi, said: “Covid-19 has forced governments and central banks to embark on a ‘whatever it takes’ wartime-type monetary response. The long-term impacts on financial markets only become evident in hindsight. Faced with such uncertainty, portfolio resilience and antifragility will be the new guiding star for pension investors.”
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