Professional Pensions spoke to three chief investment officers from some of the UK's leading asset managers about Brexit, the investment challenges facing schemes and asset allocation. This is what they said…
The panellists - Mark Burgess, Lucy Macdonald and Rod Paris - were speaking ahead of Pensions and Benefits UK on 29 June, where they will join Schroders chief executive Peter Harrison on the Investment Leaders Panel.
Chief investment officer
Columbia Threadneedle Investments
Mark Burgess is chief investment officer at Threadneedle Asset Management and also chairs the firm's asset allocation committee. Prior to joining the company in 2010, he was head of equities at Legal & General Investment Management and has also held senior roles at Morgan Grenfell Asset Management and Deutsche Asset Management.
Chief investment officer for global equities
Allianz Global Investors
Lucy Macdonald is chief investment officer for global equities at Allianz Global Investors and is responsible for around £3.5bn of assets under management. Prior to joining the company in 2001, she spent 16 years at Baring Asset Management, latterly as a director and senior portfolio manager.
Chief investment officer
Standard Life Investments
Rod Paris is the chief investment officer and executive director for Standard Life Investments and is responsible for oversight of investment activities at the firm. Prior to joining the firm in May 2002 as head of global fixed income, he held senior roles at Merrill Lynch Investment Managers and Mercury Asset Management.
What would Brexit mean for UK pension scheme investment?
Burgess: In a world in which the UK is merely an island on the edge of Europe, rather than a key part of it, sterling will look less attractive in a global context. Therefore Britain's exit from the EU - and the uncertainty in the run up to the vote - could lead to investors becoming reluctant to hold sterling assets. As a result, UK gilts would be seen as less of a safe haven. However, many gilt holders are UK pension funds, who are unlikely to be 'flighty' investors. Therefore, if Britain did vote to leave EU, it is more likely to affect pension funds' equity investments. At an industry level, Brexit would probably have the biggest impact on banking, retailing, financials, insurance and property. If the nation votes out, the overall equity market is likely to remain under some pressure as adjustment to the new reality takes place, which would present a challenge to pension schemes' already stretched funding positions.
Macdonald: The long-term implications of Brexit on the economy and investment returns are largely unknown. In the short to medium-term there would likely be heightened volatility in most, if not all, asset classes that UK schemes invest in. Gilts and sterling could sell off, at least initially, as markets price in higher risk premia relating to capital and trade flows and potentially lower economic growth. Equities could decline as well, although this could be somewhat mitigated by the significant international exposure of many of the larger companies in the index. Brexit could also impact foreign investment into UK real estate, potentially leading to disinvestment and a decline in property prices. Offshore assets in turn would look more attractive on a relative basis, which could exacerbate capital outflows. Longer term, there are a number of plausible scenarios, positive and negative, for both economic growth and investment returns. However, in the immediate aftermath of Brexit there would be a real possibility that UK pension schemes could face a scenario of higher volatility and lower expected returns.
Paris: The principle behind the European Single Market - to encourage the free movement of goods and services - has created an environment that gives individuals and businesses the confidence to invest for the long term. We believe that leaving the EU would be potentially damaging for the UK economy, and that pension scheme investment is likely to be impacted. It will undoubtedly cause uncertainty in the short term. The longer-term impact would depend on the outcome of the final arrangements agreed with the EU.
Aside from Brexit, what do you believe are the key investment challenges facing UK scheme investors over the coming six months?
Burgess: Financial markets are facing their own version of Groundhog Day. Issues that had troubled investors last year - the lack of meaningful global economic growth despite years and years of policy stimulus along with China's slowdown and the timing of the Fed's first rate rise - were all weighing on investors' minds and showed few, if any, signs of being resolved to anyone's satisfaction. Fast forward a few months and the first Fed rise is out of the way with relatively little fanfare, but the other issues remain. We are left with a world where economic growth is scarce, where the outlook for earnings is challenged, and where geopolitical risks are as elevated as they have been for a long time. The one bright spot is Japan and, even though a fair chunk of the yen's depreciation is likely to be behind us, there are grounds for optimism for earnings growth, aided by the growing realisation in Japan that companies have to be run for the benefit of shareholders as well as for the benefit of management and staff.
Macdonald: The key challenges facing UK scheme investors over the next six months are no different to those facing investors over the next several years, i.e., how to generate acceptable returns in the face of a lower return environment. With negative nominal and/or real interest rates in most developed markets, bonds offer little in the way of income or potential capital appreciation. Equities look more attractive on a relative basis although in general have limited valuation upside and will struggle to produce high returns in the absence of a pick-up in earnings growth. Alternative asset classes may offer pockets of opportunity but tend to be more niche investments. Investors will need to take on more risk and maintain a long-term investment horizon in order to successfully navigate market volatility and maximise the potential for above market returns. Active management will be the key to achieving these goals.
Paris: With many pension schemes still underfunded, and interest rates remaining low, pension plans face the challenge of trying to deliver good returns in what are difficult market conditions for traditional growth asset investors. Different financial markets are in different phases of the investment cycle. The US is at a later stage, as shown by the state of the profits cycle, the widening of corporate bond spreads and the state of company balance sheets, possibly amplified by the effects of US policy tightening. Europe and Japan are more mid-cycle, with less corporate vulnerability and still supportive policy. EM assets are suffering a mid-cycle pause with declining commodity prices and slower Chinese growth worries persisting.
How do you think scheme allocation will change over the coming year? What are the asset classes to consider, which ones should be avoided?
Burgess: To the outside observer, the environment I have described above does not sound particularly healthy for risk assets such as equities and credit. This caution is reflected in sell-side analysts' estimates of earnings growth for equities - after several years of forecasting double-digit earnings growth, the consensus expects global earnings growth of just 6.5% in 2016. This is not a disaster but hardly likely to set the world alight. In our EMEA-managed asset allocation portfolios we have continued to emphasise equities over bonds but with reduced conviction, and we have been trimming exposure to stocks on the days that markets have rallied as a risk reduction measure.
Macdonald: Pension schemes should continue to add to long-term matching assets, such as high-quality infrastructure debt, that can provide a regular stream of income. Schemes should also consider increasing and diversifying their active equity exposure as an additional alpha source. Equity returns can be harvested in a number of ways, including fundamental research, style investing and through dividend strategies. Investing globally also provides a way to generate alpha and diversify risk. High return companies that successfully access secular growth opportunities and reinvest their cash flows into their businesses typically create additional long-term returns to shareholders, which, in the current market environment, are needed more than ever.
Paris: We are seeing continued activity in pension scheme de-risking whether that be from reducing long equity exposures and moving into more diversified multi-asset approaches or through implementation of some liability hedging.
In the longer term, as DB schemes mature and become cash flow negative the search for sustainable yield will continue. In addition, trustees of DC schemes are reviewing investment strategies to support the new pension freedoms options that members have.
About PBUK 2016
Pensions and Benefits UK - London's biggest pensions and benefits conference and exhibition - will be held on 28-29 June at the Queen Elizabeth II Conference Centre in the heart of Westminster and will help you learn from both your peers and experts from across the industry.
Delegate places at the event are FREE for individuals with direct responsibility for an organisation's pension and benefits schemes.
The conference will include keynote speeches from pensions minister Baroness Ros Altmann and shadow pensions minister Angela Rayner. Other keynote speakers will include The Pensions Regulator chief executive Lesley Titcomb.
PBUK 2016 will also see the return of the Pension Prophets - Peter Askins, Robin Ellison, Roger Mattingly and Malcolm McLean - and also include the investment leaders' debate.
It will also include a keynote session on creating the right benefits package for a multi-generational workforce - hearing from McDonald's UK chief people officer Claire Hall and FirstGroup group pensions & reward director John Chilman about how employers can meet the needs of as many as five generations in the workplace.
Benefit sessions will include presentations on boosting value in your employee benefits package and using data analytics to boost your employee benefits offering & communications.
Northern LGPS will partner with ethical pensions campaign Make My Money Matter (MMMM) as part of wider plans to invest all assets in line with the Paris Agreement on climate change.
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