Recent market volatility has created a lot of news headlines, as well as causing multiple asset classes to record some of the worst annual performance since 2008. The last quarter of 2018 was particularly painful with global equities returning -10.6%, UK equities -10.2%, oil -40% and 10 year treasury yields -19%. This was mainly driven by fears of slowing global growth and investor de-risking and moving into safer assets. It is worthwhile noting that strictly speaking the definition of market volatility is markets moving a lot both down and up however, in periods in higher volatility markets tend to decline as investors panic and sell.
The cause of the volatility has not yet dissipated, and 2019 could be an even more volatile year due to a range of factors including tightening global liquidity because of the withdrawal of quantitative easing, rising interest rates, rising geopolitical concerns including Brexit, Italian politics, US political gridlock, and the ongoing trade conflict between the US and China.
But what does all this mean for pension schemes and their investments?
I think pension schemes should not be panicking. They are long term investors so should not be too duly influenced by short-term volatility. That said such volatility does provide challenges (as well as opportunities) and it does alter market dynamics. I mention below a few areas that I think pension schemes should be thinking about as follows:
- Asset switching – with such volatility schemes need to be careful when switching. The impact of market volatility can be reduced by trading over a number of days or trading on days when news announcements are not expected.
- Active management - In recent years there has been a lot of capital flowing into passive funds, due to the low cost and better performance net of fees, versus active managers. However, active management may be able to reduce volatility and provide better returns by using their skill to protect against such volatility. Also they can hold more cash in falling markets than passive managers so protecting values. This could mean active managers could outperform the aforementioned passive index funds.
- Diversified Growth Funds – If you look over the last 5 to 10 years these funds have often provided returns significantly less than equities during the bull equity market run, despite being sold as equity replacements. Perhaps they can now in a more volatile environment prove their worth and provide equity like returns with lower volatility.
- I believe that pension schemes should have trigger structures in place to benefit from any potential upside if it does occur. Given the current volatility with market movements occurring rapidly, having a robust process for implementation will benefit pension schemes and help them take advantage of these opportunities.
I am sure that there a lot more areas that pension schemes need to be thinking about and it is worthwhile that Trustees speak to their consultant about what is going on at the moment to seek their views as well as their managers’ views.