Earlier this month the International Monetary Fund warned the sovereign debt crisis could wipe out $9trn (£5.6trn) of safe assets.
The organisation argued that the amount of government debt deemed to be safe by investors could fall by a hefty 16% by 2016.
In a world where the ‘flight to safety’ is a continuing phenomenon in the markets, the IMF suggests global economic stability could be threatened if a new breed of safe assets is not created through the private sector, emerging markets and prudent regulation.
The report stated: “The shrinking set of assets perceived as safe, now limited to mostly high-quality sovereign debt, coupled with growing demand, can have negative implications for global financial stability.
“It will increase the price of safety and compel investors to move down the safety scale as they scramble to obtain scarce assets. Safe asset scarcity could lead to more short-term volatility jumps, herding behaviour, and runs on sovereign debt.”
Pension funds traditionally invest in safe assets like UK gilts and other investments likely to retain their value over a longer period. But if the IMF is correct, will pension funds be faced with the conundrum of either paying more for their assets or being forced to take on more risk?
Legal & General Investment Management head of strategy and pension solutions Marcus Mollan said pension funds needed to be “open-minded” about their asset allocations.
He said two or three years ago pension funds took a narrow view of their assets, dividing them into a “safe bucket” on the one hand and a riskier bucket on the other.
Mollan told PP: “As the report suggests, the number of assets that you can really say are super secure has gone down.”
He pointed to the risks associated with European sovereign bonds as the eurozone crisis continues to trundle onwards, but also said assets in the UK, US and Japan are no longer perceived as totally risk free.
Mollan added: “That means institutional investors like our clients will look at investment strategy and will not use this somewhat artificial division anymore between risk-free and risky assets.”
He said pension fund demand for relatively low risk instruments would continue but argued there is increasing focus on tail risk, downside scenarios and derivative strategies.
Mollan said schemes could invest in emerging market debt, lower grade corporate bonds, infrastructure assets, overseas government bonds, property, private equity and commodities to access a wider variety of risks.
Defined benefit schemes have turned to liability driven investment strategies since the financial crisis, using gilts to match their long-term liabilities.
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