Are pension funds investing in any emerging market directly, or are they using a broader approach?
The general view is that emerging economies will do better and will outpace the developed world in the years to come. UK pension schemes are interested in increasing their exposure to EM equities, bonds and also to the local emerging currencies.
Where else are investors looking for yield?
Pension schemes are being bombarded by a number of new and not-so-new strategies offering extra yield and, in some instances, capital preservation. Hedge funds have had quite a tough time in the last couple of years, but this year it appears there is some renewed interest in hedge funds and in absolute return funds or diversified growth funds (DGFs) too. DGFs generally have lower volatility than hedge funds and invest in a mix of assets run by one manager. In general, DGFs aim to preserve capital, beat inflation and diversify the portfolio by having a range of assets. Volatility of the overall fund is normally lower than for equities with the potential for returns greater than for bonds.
Are you seeing interest from members wishing to take advantage of the increasing opportunities created by banks deleveraging?
Yes. I think it is an interesting development that pension funds are taking some of the role historically held by banks because bank capitalisation is under pressure. Pension funds are asked to step up and support infrastructure projects and, in essence, support the UK economy in terms of investing for the long term. That suits our pension members who are looking for long-dated assets to match their long-dated liabilities. A match made in heaven, potentially, depending on the yield.
What are your thoughts on quantitative easing (QE) in the UK?
There is concern among investors about the timing of quantitative easing unwinding given the volatility in asset prices that the mere talk of reducing QE has caused in the US. MPC officials in the UK have however said that UK interest rates will need to head up before QE unwinding is considered. The timing of an interest rate hike in the UK remains unclear, despite the recent forward guidance from the Bank of England (BoE). This pointed to interest rates remaining at 0.5% for three years (subject to unemployment above 7% and a number of inflation-related conditions). Market expectations however are pricing in a rate hike in early 2015. QE was a necessary medicine, but it manipulated asset markets and pushed government yields to very low levels which, in turn, led to pension deficits increasing substantially. What we ask for is that when QE unwinding does come onto the agenda that the process is done in an orderly way. We would strongly suggest that the BoE speaks and coordinates the unwinding with the Debt Management Office (DMO) which has done a good job in terms of managing issuance in the past.
And what do you make of the Fed’s announcement not to taper its QE programme just yet?
UK bond yields have headed higher since the talk of tapering in the US started in May. Higher yields since then have been beneficial to those pension schemes in deficit. The announcement of no tapering in the US in September caught the market by surprise as the consensus believed that, given the improvement in the US economy, a modest reduction in bond buying would be forthcoming. Gilt yields have fallen since the no taper announcement although bond markets remain nervous of further announcements.
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