Thursday September 24, 2020

Analysis: Pension funds are down, but it’s nowhere near as bad as 2008

Given the extreme circumstances and volatile markets, an outcome of about -8 per cent for the year to date is acceptable for Irish investors – as long as there’s no second wave

11th May, 2020
The coronavirus pandemic has led to wild swings in the stock markets

Investors in Irish pension and savings funds have emerged somewhat weather-beaten from the wild swings we have been living through in stock markets since March. Month-to-month volatility has been exceptional, with violent moves both down and up.

Basically global stock markets slumped by 13 per cent in March only to recover by 11 per cent in April.

Stocks still represent the largest exposure of a traditional managed Irish pension fund, so this meant that an average fund was down between 13 and 14 per cent for the first quarter but recovered to be “only” down about 8 per cent for the year to end April.

Markets first stabilised as very substantial monetary and fiscal policy action was taken and amid tentative signs of better medical numbers and even more tentative signs of “re-opening” of economies. Markets remain very sensitive to news flow – less so around the economic numbers, which are basically written off, but to the medical data and issues such as ongoing talk of tariffs.

There wasn’t much support from the other typical assets held such as bonds. So far this year eurozone government bonds have just edged into positive territory while there has been slippage in other categories such as corporate and emerging market bonds.

Property values remain stable with retail being the weakest sub-sector. We have seen some shift away from these traditional assets and strategies in recent years. This has partly been in response to the severe market falls that occurred during the 2008 financial crisis.

Investors have looked to strategies such as absolute return funds and alternatives such as hedge funds. Absolute return funds look to generate positive returns through time but at a lower level of risk than typical managed funds. Hedge funds also have a very broad remit, and can invest in a wide range of instruments, going both long and short if required. Both types of strategies are designed to be independent of broad market returns and offer a buffer and diversification when you need it.

So far this year the main “brand” names in this absolute return space have delivered negative returns. While these returns were substantially better than outright exposure to markets, nonetheless many absolute return strategies have now failed to deliver positive returns over the longer term as well.

Hedge funds had a very difficult March, down by about 8 per cent on average. One particular sector within hedge funds which did fare better was what is labelled “macro-strategy” –where managers take views on assets classes such as currencies, interest rates, regions and so on. Macro managers in aggregate actually produced small positive returns, doing exactly what their investors would want.

In the current environment those investing in hedge funds need to be careful which ones they choose. In March there was one of the widest ranges on record between the winners and the losers. The top performing 10 per cent of funds posted an average gain of +18.5 per cent while the bottom 10 per cent dropped by -30 per cent. We did see some withdrawals from hedge funds but nothing compared to 2008. It is likely that the client base in this hedge fund arena is more institutional than before and therefore a bit more “sticky”.

In Britain an increase in the number of people withdrawing money from their savings pot has added to the impact of the crisis on pensions. Increased flexibility on withdrawals from pension funds has been in place in Britain since 2015. In the first quarter of this year there has been a 23 per cent increase in the number of individuals taking some money out of their pension fund. Given the severity of the pandemic in Britain and financial market volatility, this trend is likely to grow into the second quarter of the year, despite the rebound in April.

The better tone in financial markets in April will also be a relief to the US state pension system. The turmoil from the pandemic reduced the financial strength of the US state pension system to its weakest level in over 30 years. The asset values of 130 of the largest state pension plans declined by 16 per cent in March alone. This issue in the US is highly politicised, with Republicans showing no desire to bail out “blue state” pension schemes. Better markets will help, but even more important will be a better US economy as the strains on state pension plans are set to intensify due to the huge rise in US unemployment which will cut tax revenues and raise benefits.

While this year has been volatile in the extreme, an outcome of about -8 per cent for the year to date is acceptable for Irish investors, given the carnage in economies and corporations. By comparison, in 2008, pension funds suffered a 36 per cent decline.

As countries begin easing restrictions put in place to battle Covid-19, one other issue is worth noting. At this stage the markets do not appear to have priced in a severe second wave of the pandemic or a return to lockdown.

Eugene Kiernan is an independent investment strategist

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