Despite it all, the rest of us must keep doing what we do.
At the time of writing (10 March 2022), most UK pension schemes have suffered only limited damage. Direct exposure to Russia, Ukraine and Belarus may have to be written down, but is small. Yes, there are some indirect impacts. Equity markets are down and inflation is up, but gilt yields are up so funding levels are probably similar or slightly down overall compared to a few weeks or months ago.
Those who were hoping for Western central banks to significantly raise short term interest rates will probably be disappointed. They are caught between an inflation rock and an economic growth hard landing and could have to choose one or the other.
Big geopolitical events often accelerate existing trends or turning points. COVID/lockdowns accelerated the use of certain technologies and the simplification of supply chains. Russia/Ukraine seems to be highlighting the importance of energy security and financial counterparty risks.
How will ESG and carbon net zero objectives be affected by a greater focus on national energy security and increased defence spending? There are some suggestions that the defence sector should be classified as ESG friendly if used against Putin. This would be to allow greater investment in the defence sector. Are fossil fuels now climate friendly if used to build electric vehicles and solar panels?
Trust can take a long time to gain and be lost in a heartbeat. The US, EU and UK may have over-played their poker hand by freezing some of the assets of the Russian central bank. Wanting to punish and isolate is understandable, but for overindebted governments to tell the world that their dollars, euros or pounds could be set to zero at the whim of politicians is not a world of certainty and predictability in which trade and economic growth thrives. Also, if the Middle East countries now look towards Russia and China rather than the US, then it could signal the end of the petrodollar and Bretton Woods II.
I don’t mean to be gloomy, but does the world now feel more uncertain to you than it did a few years ago? Maybe I should turn off the news…
Because it’s easy to get distracted. We should all focus on what we do best, what we can control, and where we want to get to.
Even in scary times (maybe because they are scary), there will be great opportunities. Write down what you want and get ready now. Snap up those gilts when yields rise. Grab those bulk annuities when credit spreads rise. Maybe top up your equities after a crash – it will feel difficult at the time, that’s why everyone else hasn’t done it yet.
Stick to your principles. Keep the big picture at the front of your mind. Ignore the noise – there’s plenty of that. Diversify and reduce risk when you can afford to – don’t get greedy. Know your investment time horizon and always make sure you can pay members their benefits when due.
Credit spreads are rising. An ominous sign economically. But good for those buying bulk annuities and recycling short duration corporate bond payments who can lock in those higher yields. Less liquid credit/debt could also be attractive, provided you size your allocation properly (not too big).
Inflation is high and could go higher. DB schemes usually have some protection because annual pension increases are capped at 5% or 2.5%. Want more protection? LDI is a fantastic tool for direct inflation hedging. Some growth assets such as long lease property and ground rents have inflation embedded within the underlying contracts, but these assets are scarce and highly sought after so can be expensive.
Got a long investment time horizon and not bothered by short term volatility? Find some hard assets, meaning it’s difficult to make more of them. Traditionally equities and commodities have been used by pension schemes. Property is also still an option. Maybe it’s finally time for gold to shine again after all these years, or the new hard money on the block: bitcoin.
Pensions and investments are complicated enough already: keep as simple as possible, but no simpler, as the famous saying goes.
Stay positive. As ever, those trustees that know what they want and are ready to act quickly will come out of this in the best shape.
Sam Roberts, Director of Investment Consulting, Cartwright
