Moderated by Adrian DEARNELL, Chairman, EuroBusiness Media

Increasing longevity impacts the sustainability of heterogeneous retirement systems worldwide, making it necessary to address and rethink savings solutions up to and through retirement. While we can observe diverse local initiatives to strengthen the pension system, the common consequence across the globe is an increasing level of risk-transfer to the end-savers.

The moderator asked the panellists to explain the retirement systems in their regions and the strategies they are developing to meet the needs of ageing populations.

Stephen Gilmore said that the focus in Australia is on strengthening budgets. Every five years, the government undertakes an “inter-generational report” that looks at the implications of the ageing population for future budgets. This has shown that the budget would come under pressure, so the government decided to delay drawing down on its $140 billion sovereign wealth fund to ensure that its capital lasts longer.

In addition Australia has a compulsory contribution super-scheme with an initial contribution of 3% of salaries. This has risen to 9% and will rise again to 12%. A commission is valuating where best to invest these funds. Finally, the Treasury has been working on comprehensive income products for retirement, since current ones focus on the accumulation phase, rather than decumulation.

PAY-AS-YOU-GO OR MATCHING-CONTRIBUTION SYSTEMS – BOTH NEED GOOD RETURNS

Jansen Phee then explained that most pension systems around the world rely on two mechanisms, a pay-as-you-go system for the worker and a system where employers match contributions. You access the accumulated funds on retirement. In Asia most countries follow one or the other or a combination of the two. However there are challenges on their sustainability.

Three issues play into this. One is the demographics of ageing populations, which will put stress on funding these systems going forward. The second is public finances, since many governments have already spent too much to maintain the systems. And the third is today’s low interest-rate environment, which limits the returns pension funds can obtain. Some of this is cultural, he explained. Many Asians have focused mostly on accumulating wealth, with little regard for what will happen to them when they retire.

« The low interest-rate environment in which we live puts a cap on how much return pension fund systems can obtain over the investment cycle. »

Jansen Phee

« The low interest-rate environment in which we live puts a cap on how much return pension fund systems can obtain over the investment cycle. »

Jansen Phee

John St-Hill continued that in the UK, with a low-yield environment and requirement to bring pension liabilities onto the balance sheet, the number of final-salary pension schemes has declined by about 25%. NEST was created with auto-enrolment to encourage individuals to make personal long-term provisions. Employers have to provide a savings scheme for all employees with earnings over a particular threshold. Since it is uneconomic for insurance companies to provide these, NEST steps in when employers are unwilling or unable to find other solutions.

When the legislation was set up, workers were to contribute 1% and employers 1%. Over the next three years, this will increase to 5% and 3%. The system is designed to transfer some of the risk from the employers to individuals. The goal is to enable people to have better long-term retirements, which requires generating income over the whole savings lifetime. The hard thing, particularly in a direct-contribution context, is for individuals to get access to long-duration, low-liquidity assets that correlate with their personal liabilities.

Mr. Gilmore agreed, adding that is important to be realistic. Few appreciate what future returns as low as 4% mean for retirement income accumulation, which has implications for how long they have to work and save. It is also important to understand the risk profile of the beneficiary, which will change over time.

Matteo Germano emphasized that long-term investment should be an easy call, with 1.5-2% liquidity that can be “harvested”; but in practice this is nothappening. Investing for the long-term means understanding the trends that generate long-term premiums. Any dislocation of price must be seen as an opportunity to adjust holdings, but decisions should be based on the underlying long-term intrinsic value of the asset class. Volatility cannot be the measure. The focus is shifting from market risk to credit risk and into liquidity risk. “If you manage these, you can invest in distressed assets, in real estate and other real assets and get the 1.5% in extra premium”.

Investing for the long term has important advantages, continued Mr. Germano. It allows you to be investor-compliant and not a forced seller. You are not chasing a benchmark or peers, and can invest across all risk factors, including ones such as ESG that unfold their value in the long-term. It also reduces transaction costs. The negatives are that you have to bear the pressure of downturns, because long-term timing is difficult. A solution Amundi is implementing for this is backing the entire portfolio.

ENCOURAGING LONG-TERM, DIVERSIFIED SAVINGS

The natural objective of long-term savings is to protect accumulated capital against erosion from inflation, while potentially generating a supplementary return over inflation. While this may seem like a simple goal, it is not easily achieved over the long run, particularly in the current low int rest rate environment, which is starkly different from the one we have known for the last 40 years.

Long-term financial management is based on a few simple principles:
• Positive rewards for risk-taking mean that retirement savings cannot be placed solely in risk-free investments. Even highly risk-averse people must invest a small portion of their portfolio in risky assets to benefit from the increased returns.
• A money market investment is risk-free only in the short term. A strategy based on rolling over a money market investment year after year is not risk-free in the long term, because interest rates fluctuate over time and protect capital only partially against inflation.
• A long-term investment has to be diversified in bonds (ideally inflation-linked) and higher-risk investments such as equities and real estate (and other alternative and real assets). The benefits of diversification are substantial and can drastically lower a portfolio risk. For example, a portfolio that is invested in both equities and bonds will significantly reduce the risk compared with a portfolio that is entirely invested in either equities or bonds.

« The end-goal is really to enable people to have better long-term retirements. This speaks directly to finding ways to generate income over the total savings lifetime. »

John St-Hill

« The end-goal is really to enable people to have better long-term retirements. This speaks directly to finding ways to generate income over the total savings lifetime. »

John St-Hill

THE FEAR OF GOING LONG TERM

This is a good point, interjected Mr. St-Hill. “Although clients say they want you to be long-term, the first time they experience a material draw-down tends to scare those long-term goals out of their immediate focus.” This is particularly important in the retail space, since individuals can withdraw or stop contributing in response to short-term performance. One strategy is to have lower levels of risks in the early days for investors in target-date funds, since when they are learning to invest they have a higher propensity to sell at the first sign of a downturn.

Mr. Phee explained that at UBS APAC the concerns are the same. To guide clients UBS uses a “Three L” framework. The first L stands for Liquidity strategies, the second for Longevity strategies and the third for Legacy strategies. The liquidity strategies are strategies whereby clients invest over 1-3 years to meet short-term needs. This includes cash or cash-like instruments and high-quality short-dated bonds. The aim is to have minimal risk with a modest return and high liquidity. The longevity part is the bulk of the assets clients use for the remainder of the lifetime, with multi-asset solutions with a growth bias to get above average returns. And the legacy part is assets that are in excess of what the client needs and wants to pass on to heirs or charity.

Mr. Germano pointed out that the majority of the mandates Amundi receives as an asset manager do not necessarily have the same goals as those of the final clients. It would be good to find alignment, since ultimately clients want to maximise their entire income and not just their income at retirement. This means that the primary goal has to be income, while portfolio management must be focused on drawdown, which can reduce the ability to generate income.

« It is important to understand the risk profile of the beneficiary, and that risk profile will change over time. It is also important to have flexibility, because needs will change »

Stephen Gilmore

« It is important to understand the risk profile of the beneficiary, and that risk profile will change over time. It is also important to have flexibility, because needs will change »

Stephen Gilmore