The trend of pension funds de-risking their portfolios should make them wary of contributing to a bubble in low-risk holdings, leading asset managers have claimed during a panel debate on the future of investment

Tim Gardener, global head of consultant relations at AXA Investment Managers, told an industry conference in the UK that there was an obvious bubble that had been created over the past two decades with pension fund and insurance company money leaving the equity market for the bond market.

"It's much bigger than the tech bubble for me, and the question is 'when is it going to burst?'" he said.

Gardener explained that a complete de-risking of UK defined benefit pension funds could not be completed by using index-linked gilts alone "as there is only enough index-linked gilts in issue to cover 25% of liabilities. That means the price of index-linked gilts is expensive and a fund could get caught out by de-risking when the bubble bursts."

Gardener advised pension funds to delve into volatile equity markets, saying: "if everyone is selling equities this presents, (with) all other things being equal, a great opportunity. As a long-term investor, especially for defined contribution funds. Do you care about what happens in the course of a month? No. I don't know what the inverse of a bubble is but if you have a bubble in one asset class that inverse is probably happening somewhere."

A number of other managers joined Gardener in the debate. One of them, Charles Baillie, head of global portfolio solutions at Goldman Sachs Asset Management said that pension funds should not view de-risking as a cautious "one-way path" as they "have to take on more risk to close deficits."

Baillie says fiscal policies in the developed world such as the US Federal Reserve's recently renewed 'operation twist' have the effect of encouraging investors to put money in risky assets by pushing sovereign bond yields lower. He said: "Trying to go into low-risk assets at a time when governments across the world are trying to push you in the opposite direction seems a pretty difficult proposition."

You can't eliminate all risk

But Hendrik du Toit, CEO of Investec Asset Management, speaking at the same forum, warned against the use of derivatives to hedge the risk of pension schemes, saying: "We should be wary of looking for solutions in assets that are priced slowly or in a non-transparent way. I'd much rather be in an asset I can sell like UK gilts than one that assumes safety but has a big liquidity gap at the selling point."

Andrew Kirton, global CIO of Mercer said "there is great deal of opportunity at the moment for cash rich investors" willing to embrace new opportunities like replacing some of the lending that banks have scaled back from in the likes of property debt. He added that pension funds "can invest in infrastructure over the next few years that will help turn this country around. Really in the long-term it will be a recovery in the economy that takes pension schemes forward".

As well as offering the general advice of becoming willing to embrace risk, the investors cautioned that funds should better understand risk in all its forms. Gardener said "there is a lot more to risk than volatility. There is a plurality of risk in investing in infrastructure for instance, as this brings clear political risk in the shape of nationalisation."

Gardener added: "I am nervous that a lot of so-called low-risk assets only focus on equity volatility and offer solutions to yesterday's problems rather than tomorrow's."

Gardener argued that pension funds can't ever eliminate risk entirely, saying that "as a pension fund trustee you can't do a lot about the demise of the West or an invasion, but by focusing on what you are able to do you can add some value to your scheme."  

First published 22.09.2011

dbillingham@wilmington.co.uk