For professional investors only. Not suitable for retail clients.
Autumn 2015
Schroders
Pensions Newsletter
Regulators turn their spotlight onto
asset managers and their clients
Many of us may dream of a world
when board or trustee meetings are not
dominated by regulatory questions, but
sadly that remains a long way off. Indeed,
the regulatory spotlight is now moving from
banks and insurers to asset managers and
their clients. Clients are being required to
be more than just passive users of services,
but to hold managers to account, to
scrutinise disclosures and to consider the
impact of their actions on, amongst other
things, the stability of markets.
In February the Financial Conduct Authority
(FCA) published responses to its call
for evidence on whether competition is
working effectively in wholesale financial
services*. One that specifically related to
fund management clients suggested that in
some cases “those overseeing the selection
and oversight of asset managers may lack
the necessary resource and/or expertise to
do this effectively”. Another was that “only
a small proportion of defined contribution
schemes had a formal process to assess
the quality of the services provided by
investment consultants”.
Following on from this, we are expecting
the FCA shortly to publish the terms of
reference for a market study of competition
in the asset management sector.
Trustees of pension schemes will have an
opportunity to comment on the service and
value they receive from asset managers,
but are likely also to be asked questions
about their own role in holding managers to account.
Meanwhile, two recurring themes that are
currently exercising UK and EU regulators
are disclosure and transparency. UK
trustees are already required to report
on transaction costs and administration
charges. In the future, the Markets in
Financial Instruments Directive II (MiFID
II), due to take effect in January 2017,
will impose new disclosure requirements
on asset managers. They have yet to be
finalised, but they may include information
on dealing charges and investment
research costs. Trustees can expect
regulators to ask them what they do with
this information when they get it.
* ”Wholesale sector competition review 2014-15”, Feedback Statement, FS15/2, February 2015.
A wave of regulation is due over the horizon in the next 18 months
EU: MiFID II
Anti-money laundering,
bribery and corruption rules
EU: Market Abuse Directive II
Global: derivatives clearing and reporting rules
Global: regulatory scrutiny of
systemic risks in asset management
EU: Capital Market
Union proposals
EU: Shareholder Rights Directive
FCA: asset management
competition market study
www.schroders.com/ukpensions
Contents
Where next for quantitative
easing?
2
Forthcoming events
2
Is an ageing population a double
whammy for pension schemes?
3
Funding level tracker
3
DC: why market wobbles can
lead to bad behaviour
4
More widely, banking and insurance
regulators are well on the way to identifying
institutions whose failure could have an
impact on the overall financial system.
The focus is now turning elsewhere and
the G20 group of nations has therefore
mandated the Financial Stability Board and
the International Organisation of Securities
Commissions to identify non-banking
institutions that are systemically important.
Recognising the difference between banks
and asset managers, the two groups
have concluded that their priority here is
to scrutinise the impact of the activities of
asset managers and their clients, rather
than the failure of one of their number.
Their primary concern is the impact of
significant withdrawals on increasingly
illiquid markets. Therefore, it is as much
about the behaviour of clients as about
asset managers themselves. One of the
issues they need to understand is the likely
behaviour of both retail and institutional
investors in circumstances such as a rise in
interest rates.
So, far from the regulatory debate receding
into the background, it is becoming more
important than ever for trustees to engage
actively in the discussion. Engagement
provides an opportunity for your voice to be
heard and to ensure that policy is formed
on the basis of a full understanding of how
the market works and what you, as a client,
want from your fund manager.
2
Schroders Pensions Newsletter Autumn 2015
Forthcoming
events
Where next for quantitative easing?
THE THEORY
Bank of England uses “electronic money” to buy
government bonds, pumping money into the system.
Treasury
stock
At our DC conference next year we’d
like to put part of the agenda into your
hands. One session will be devoted to
addressing the investment issues that
matter to you as a trustee, employer
or governance committee member. All
we’re asking is for you to get in touch
and tell us what issues and problems you
would like to hear more about.
Banks receive cash which they use
to increase lending.
Higher demand pushes up bond
and share prices; reduces yields.
Defined Contribution Conference
– 19 May, 2016, Royal Institute of
British Architects, London
Anyco PLC
Lower yields cause the
pound to fall, boosting
exports and inflation
Send us a short email with your
suggestions at
ukpensions@schroders.com
Widget PLC
Lower yields encourage
companies and consumers
to increase investment
and consumption
Higher prices for assets
such as stocks and
houses make owners
feel richer
FTSE
Trustee training
Our half-day training sessions around
the country are open to anyone involved
in pensions who wants to increase
their investment expertise. They are
led by Schroders’ professionals with a
wide range of experience in the topics
covered. These usually include the role of
equities, bonds, property and alternative
assets in building portfolios, and the
vital importance of asset allocation.
Attendance at our trustee training events
qualifies for continuing professional
development (CPD) credits.
THE REALITY
Consumption,
investment, exports
and inflation have
remained weak,
but asset prices
have jumped.
Global fixed income web
conference
Every month our fixed income team runs
a short web conference looking at the
outlook for the global bond market. All
our readers are warmly invited to join
the conference.
Register for the next event at
www.schroders.com/watch
on,
umpti
Cons
t,
tmen
inves s &
export n
o
inflati
QE
Widget PLC
WHERE NEXT?
A new schedule of events will be
announced in early 2016.
Housing,
bonds &
shares
Things go well
Things go badly
Stagflation:
Inflation soars,
exchange rate sinks,
growth slumps and
interest rates jump to
restore equilibrium.
Goldilocks:
Inflation nears 2% target,
Bank sells bonds to
reabsorb excess money;
economy returns to
steady growth.
Housing,
bonds & shares
Widget PLC
Consumption,
investment,
exports & inflation
Consumption,
Investment,
exports & inflation
Widget
PLC
Housing,
bonds & shares
For more information see "Interest rates: is there no risk of significant rate hikes?", Keith Wade and Alessandro
Rocco, Schroders, August 2015, and "Life after QE - what's next for markets?", panel discussion, Schroders
Investment Conference, October 2015.
Schroders Pensions Newsletter Autumn 2015
3
Could an ageing population be a double whammy for
pension schemes?
Earlier this year the Bank for International
Settlements (BIS) published a paper1 on the
effects of demographics on inflation. Its conclusions were surprising and could
have profound implications for pension
scheme trustees and sponsors. Rather than
reducing inflation, the research suggests that
an ageing population may actually produce
higher inflation.
The prevailing view is that, all else being
equal, older populations should create
less inflationary pressures than younger
populations. After all, retired people are less
economically active than working people,
which should lead to lower economic
growth and, therefore, lower inflation. Also,
retired people tend to be more exposed
to the negative effects of rapidly rising
prices. This should, in theory, lead to more
political pressure on governments with older
populations to control inflation.
The BIS paper examined the inflation and
demographic experience of 22 countries
since 1955. Its conclusion is that populations
with a higher dependency ratio (more young
and old non-workers compared to working
people) have tended to experience higher
inflation. One explanation for this is that the
elderly and children consume more than
they produce. This leads to excess demand
in an economy, which pushes up inflation.
They argue that this effect may outweigh the
factors traditionally cited as pushing in the
opposite direction.
The BIS study suggests that the global
economy has benefited from lower
inflationary pressures by around four per
cent over the past 40 years due to an
increase in the relative share of the working
age population. This has broadly been as a
result of the baby boomer generation having
fewer children. However over the next forty
years the authors predict demographic
tailwinds will change to headwinds as
populations around the world age and
dependency ratios rise. The BIS estimates
that, in the UK, the ageing population will
lead to inflation that is 2.5% higher in 2050
than it would have otherwise been if left
unchecked.
Should they prove correct, the conclusions
of the BIS report could have profound
implications for UK pension schemes.
Ultimately, whether they do will depend on
the impact of demographics on inflation,
interest rates and economic growth. If
central banks leave inflationary pressures
unchecked, then pension schemes’
inflation-linked liabilities will rise. Using the
BIS estimate for the UK, an inflation-linked
pension payment due in 20 years’ time
would be worth 13% more and a payment
in 40 years’ time would be worth around
60% more2. Defined contribution members
will also face greater cost of living pressures,
as well as having to fund a longer retirement
due to the longer lives they are expected to enjoy.
However, if central banks adopt stronger
measures to control inflation, for example by
raising interest rates faster than expected,
the result could be beneficial for defined
benefit pension schemes if discount rates
also rise. While higher inflation would
require higher levels of pension to be paid,
the discounted value of pension liabilities
could be smaller if interest rates turn out to
be higher than expected. This assumes,
of course, that the benefit is not offset by
weaker economic growth and poorer returns
on equities and other growth assets.
So if the BIS research is to be believed,
increasing longevity may be a double
whammy for pension scheme trustees
and sponsors. As well as extending the
period over which they must be paid, longer
lives may require pension payments to be
increased to match higher inflation. This
could raise the pressure on trustees to
explore inflation protection strategies, such
as liability-driven investment.
1 Bank for International Settlements Working Paper no.
485, “Can demography affect inflation and monetary
policy?”, Mikael Juselius and Elöd Takáts, February 2015.
2 Assumes linear increases in inflation over 40 yrs, ending
2.5% a year higher than current break-even yields suggest.
Funding levels take a turn for the worse as growth assets fall
Following a brief respite in early 2015, pension scheme funding levels have taken a turn for the worse, extending a downward
trend that started at the end of 2013 (see chart). Average funding levels were growing steadily in the first half of 2015, boosted by
growth assets outperforming liabilities at the time. This all changed over the summer, as the outlook for growth in China and other
emerging markets caused investor confidence to dip, resulting in a sharp downturn in asset values.
Our funding level tracker uses annual defined benefit asset and liability
values from the Pension Protection
Fund’s Purple Book1. Between these
updates, our UK Strategic Solutions
Team estimates how funding levels
have changed each month.
The downward drift in funding levels has resumed since the summer
Longer-term trend in funding level
80%
75%
70%
65%
–– Changes in asset values are
based on values for market
indices that represent the average
pension scheme asset allocation
60%
–– Changes in liability values
are based on yields on gilts
that are similar to a typical
scheme’s liabilities.
45%
1 http://www.pensionprotectionfund.org.uk/Pages/
ThePurpleBook.aspx
55%
50%
40%
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
Gilt-based funding level
Sources for funding level estimates, total asset and liability values (buyout basis) and average asset allocation: Pension Protection Fund as of 31 March each year (to March 2014). Interim asset returns: MSCI, FTSE, Barclays,
Bloomberg, IPD and HFRI gilt yields: Bank of England; all as of 30 September 2015.
4
Schroders Pensions Newsletter Autumn 2015
DC: why market wobbles can lead to bad behaviour
Our consumer research suggests that the
August dive in markets – when the MSCI
World Index lost 11% in a fortnight – has
knocked the confidence of many DC
savers. For those with a default fund heavily
orientated towards equities, particularly the
many in index funds, their pension pot will
have taken a dive from which it has yet to recover.
While only the more alert DC members
are likely to be aware of the impact of the
market’s wobbles on their pensions, we
think they should set alarm bells ringing for
those who look after them on their behalf.
DC trustees, independent governance
committees and employers may struggle to
explain to members that the volatility they
have endured is a price worth paying to
achieve the growth they need to meet their
retirement ambitions. Even more so if there
is little sign of recovery in sight by the time
they have to report to members.
This can make life difficult for trustees and
others charged with the duty of overseeing
the scheme and, more particularly, the
default fund. One thing that would make life
much easier for schemes would be if the
saver’s default fund could be managed to
provide smoother returns in the first place.
An investment vehicle that provided growth,
while also aiming to reduce the trauma of
turbulent markets, would vastly improve
communication with members.
Most experts would probably acknowledge
that a diversified portfolio is one of the
best platforms for achieving the stable
growth that many pension savers need.
The ability to use a wide range of assets,
Contact
James Nunn
UK Institutional Business Development
+44 (0)20 7658 2776
ukpensions@schroders.com
from government bonds and equities to
commodities and absolute return funds,
should both improve the prospects for
growth and reduce the likelihood of loss.
But, however well designed initially, a
rigidly diversified portfolio is seldom
best positioned as the environment
changes. Ideally, asset allocations should
shift to address conditions as they are
encountered. The only truly effective way of
achieving such dynamism, we believe, is for
the asset allocation to be actively managed.
That way it can adopt a defensive position
when the need arises – such as in August
– and can be quickly readjusted to benefit
from upward moves in asset prices when
the market recovers.
We know that this sort of intelligent asset
allocation is even more important for the
typical investor than clever stock picking.
It is why we think, in a world increasingly
aware of costs, the limited fee budget
available for the default fund is better spent
on expertise in choosing the asset line-up
than individual stocks. This can only really
be provided if the fund is steered by expert managers.
Luckily, our experience is that all the
dynamic features needed to run a
successful diversified growth portfolio
can be combined in a default that costs
significantly less than the maximum fee
mandated by the government’s charge cap.
Indeed, by adopting innovative ways of
gaining access to asset returns, we believe
asset management fees can be reduced to
less than 0.5%.
We think such a fund should generate
fewer heart-stopping moments than a
pure equity fund, but also provide a more
intelligently-managed balance between
risk and reward than a rigidly diversified
growth fund. Using such an approach
should make for a smoother journey for
members (see chart). And that is important
because, while investment risks may loom
large in the short term, they are likely to
prove much less serious than the risk of
not achieving enough growth over the long
term. We believe a dynamically-managed
diversified growth portfolio can go a long
way to ensuring the former do not fatally
undermine the latter, helping to provide just the right balance for many savers in DC defaults.
Steering a smoother path with a dynamically-managed diversified portfolio
120
115
110
105
100
95
Nov
2014
Feb
2015
Schroder Life Dynamic Multi Asset Fund
May
2015
Aug
2015
MSCI World GBP
Nov
2015
Cash
12-month total return performance to 2 November 2015, rebased. Cash is represented by 3-month UK LIBOR. Past
performance is not a guide to future performance and may not be repeated. Source: Bloomberg, MSCI and Schroders.
Important Information: For professional investors only. This document is not suitable for retail clients. Past performance is not a guide to future performance and may not be
repeated. This document is intended to be for information purposes only and it is not intended as promotional material in any respect. The material is not intended as an offer or solicitation for the
purchase or sale of any financial instrument. The material is not intended to provide, and should not be relied on for, accounting, legal or tax advice, or investment recommendations Information herein
is believed to be reliable but Schroder Investment Management Limited (Schroders) does not warrant its completeness or accuracy. No responsibility can be accepted for errors of fact or opinion. This
does not exclude or restrict any duty or liability that Schroders has to its customers under the Financial Services and Markets Act 2000 (as amended from time to time) or any other regulatory system.
Schroder Dynamic Multi Asset Fund: Exchange rates may cause the value of these investments, and the income from them, to rise or fall. The fund may invest in derivatives and in alternative
investments (hedge funds, property funds and private equity) which involve an above-average degree of risk and can be more volatile than investment in equities or bonds. The fund is not tied to
replicating a benchmark and holdings can therefore vary from those in the index quoted. The comparison index should be used for reference only. Funds which invest in a smaller number of stocks
can carry more risk than funds spread across a larger number of companies. Schroders has expressed its own views and opinions in this document and these may change. Reliance should not be
placed on the views and information in the document when taking individual investment and/or strategic decisions. FTSE International Limited (“FTSE”) © FTSE. “FTSE®” is a trade mark of London
Stock Exchange Plc and The Financial Times Limited and is used by FTSE International Limited under licence. All rights in the FTSE indices and / or FTSE ratings vest in FTSE and/or its licensors.
Neither FTSE nor its licensors accept any liability for any errors or omissions in the FTSE indices and / or FTSE ratings or underlying data. No further distribution of FTSE Data is permitted without
FTSE’s express written consent. Issued by Schroder Investment Management Limited, 31 Gresham Street, London EC2V 7QA. Registration No. 1893220 England. Authorised and regulated by the
Financial Conduct Authority. For your security, communications may be recorded or monitored. w47973