By Michael O’Higgins
This month the LGPS submitted their final consultation responses to the government on its pooling agenda. The speed and willingness with which funds responded was exceptional.
However, it is essential that as an industry we don’t feel we’ve reached the finish line. The next 18 months as funds come together are even more important than those which have preceded them. While the July deadline could be seen as a hurdle, I believe it’s simply a temperature check. This is made even more important when viewing changes in the context of an ever changing, volatile external environment.
We only need to think back to 10 years ago, when it seemed that not only in the financial world, but across the globe we had a relatively benign environment with occasional crises, whereas now volatility seems to be the default state, with the occasional period of calm in between.
This level of volatility means that pension funds need to think long term and to seek liability-matching returns. Alternatives and illiquids therefore present a great fit – hence the performance of the Dutch and Canadian pension funds over time. Now more than ever, with today’s excitable markets, there is a need to keep that long-term focus.
However, this brings with it a series of trade-offs; how do you balance objectives that may be both desirable but competing? Do funds seek liquidity or look for locked-in returns? Is it preferable to seek volatility or the safer bet of slow but steady? This sort of balancing act is one of the most difficult in pensions policy to explain and justify to a wider, less professionally engaged audience.
Having said that, if I think back to my time as UK Pensions Regulator, I also had to give these sort of trade-off messages to those intimately involved in the pensions world.
So, perhaps unusually for a regulator, I cautioned pension trustees and their professional advisers to guard against ‘reckless prudence’ – being so afraid of risk that returns were avoided. I described investing in annuities at a particular time as ‘return-free risk’. So balancing security of a (lower) income against the risk or volatility of a potentially higher figure is a tough balance to find.
This particular trade-off becomes a sharper question in the context of demographic change, with the ever-increasing flow of statistics on the size of the workforce compared to the numbers of elderly people whom it is presumed they will have to support.
While some view these changes simply in terms of assets under management, I firmly believe that effective management of a pension fund requires knowledge and management of both sides of the balance sheet – investment and risk. It takes all aspects of a pension fund to be managed together to make deficit reduction a realistic, achievable and sustainable proposition. Only by doing so can funds effectively manage their deficits and secure the long-term interests of their members.
Michael O’Higgins is chairman of the Local Pensions Partnership
