Challenging times for pension funds

As demographic changes place enormous pressures on governments and companies alike to fund their growing pension deficits new strategies are required for pension funds to escape underfunding in the future.

Following a workshop on the issue organized last week by XS Capital Securities & Financial Services we had the opportunity to speak to Philipp Roeh, Head of Individual Mandates within the business area of Multi Asset Class Solutions.

 

Q What are the major challenges facing pension funds today?

 

One of the biggest challenges of pension funds is to recognize the structural trends arising from demographic changes to successfully develop and implement a set of measures that will address the new requirements from an investment management point of view. What I mean by that is that a pension fund must be aware of the financial pressure arising from changes in the population’s age structure, life expectancy, fertility rates, health care projections, migration, structure of the labor force, saving and consumption patterns etc. The successful development of an appropriate investment strategy will be the single most important factor that will determine performance results in the future. The implementation of such a strategy has to be seen in light of the new opportunities arising from Cyprus joining the Euro zone next year. Specifically, pension funds in Cyprus will have better access to Euro denominated securities and financial instruments to address specific investment needs.

 

Q Many of the types of products you just mentioned are foreign to most pension funds in Cyprus and there is an apparent reluctance in investing in securities which probably explains why nearly 80% of their holdings are invested in fixed income or even are held in deposit accounts

 

It will take time, information and training to overcome this particular issue but I believe that opportunities are available to pension funds to tackle this challenge especially if they have the help of a qualified partner. If these funds want to successfully meet the performance requirements arising from the macroeconomic and demographic environment in the long term then a higher exposure to equities seems almost inevitable. Typically, there are three steps involved in defining such a strategy. First, an asset liability study must be carried out which will result in a specific risk-return profile. Second, is the definition of the long term asset mix that will then represent the benchmark. This will serve as an objective measure of the funds investment success over time. Third, is the implementation of that strategy, monitoring and control of the results including tactical considerations, such as the choice of investment style (i.e. active versus passive instruments). For example, the pension fund must decide whether it will choose an exchange traded fund to replicate market performance or pay a fee to an active manager with the objective of achieving a relative higher performance compared to the market.

In this context the choice of the most appropriate investment solution within a disciplined investment process based on sophisticated risk management has emerged as a key success factor for pension funds in Europe. A target volatility type of solution based on the optimal risk budgeting approach of Credit Suisse may represent such a solution depending on a pension fund’s requirements. Over the coming 12 months, a total return strategy relying on bonds for performance contribution will likely fail to meet the investment objective as we believe that bond markets will have below average returns and equity markets will continue to outperform fixed income instruments. The challenge to meet the performance objectives of a pension fund consistently over time is enormous. But returns come to those who are able to identify, monitor and control risks in the context of an appropriate investment strategy.

 

XS Capital

XS Capital Securities and Financial Services Ltd. is an asset management house licensed by the Cyprus Securities and Exchange Commission (CySEC) for the provision of asset management, investment advisory and corporate finance services. The company is an External Asset Manager for Credit Suisse Zurich, and leverages this relationship to provide exceptional investment services either directly or through Credit Suisse Private Banking.

The company specialises in property fund management having successfully funded and launched three property funds investing in south east Europe.

XS Capital and its directors remain the key local advisors to overseas institutional investors such as Blakeney Management, Bank of New York, AIG and Salomon Smith Barney.