Indeed, according to a recent report by TheCityUK (click here to download the full survey), it’s not only Europe’s periphery countries that are in financial dire straits. The report, which focuses on European public pension funds, makes no bones about the fact that several state pension plans in the U.K. and Europe at large are looking at serious funding shortfalls – not only because of poor return assumptions, but also because more people are living longer and using up the cash.
According to the report, global pension assets grew by about 8% to $31.1 trillion at the end of 2010, building on an 11% rise from the year before, thanks in large part to the broader financial market recovery. The recovery has not only fueled better returns in direct investments like stocks and bonds, but has also generated better results from allocations to outside mandates – particularly alternative ones.
Indeed, key asset classes showed positive returns in 2010 for the second year running, according to the report, thus helping push overall asset levels closer to the $31.9 trillion high reached at the end of 2007. (See chart below.)
The problem is on the liabilities front, which has continued to escalate despite asset gains. While part of the issue can be attributed to timing, i.e. taking hits on bad investments and being loathe to wade back in when markets started recovering, the crux of the problem relates to rising life expectancy in major economies, which has kept the asset-liability indicator around its low point of 68 in 2008.
“The weight of liabilities continues to pose a major challenge to the funding of defined benefit (DB) pensions globally, with the aggregate deficit of companies in the FTSE Global 100 index remaining high at €160 billion at end-2010,” the report notes.
But what’s bad news for pension plans is at least partial good news for hedge funds. While the study chastised hedge funds for having a much higher correlation to the 2008 equity market sell-off than expected, it also noted how the recovery in asset values over the past two years has been particularly thanks to alternative asset classes.
Another feather in hedge funds’ caps: While the share of equities that developed world pensions have been allocating to has slid over the past few years, de-risking policies facilitating a shift away stocks and into hedge funds and other kinds of alternatives has risen. The chart below shows that, among the 5 biggest countries with stakes in broader financial markets, U.S. pensions had the highest share of equities in their portfolios (58%) and the Netherlands the lowest (28%).
To be sure, investment difficulties and indecent returns aren’t the only things keeping pensions in deficit. Beyond people eating up more pension money to keep on living, pay-as-you-go defined benefit plans and the rising cost of financing them also have an impact on the liability front.
And what are companies and governments doing about the problem? The report doesn’t speak to everyone, but it does provide some info on what the U.K. government is doing to remedy ailing pension schemes. The plan is to roll out new legislation aimed at increasing the retirement age to 66, implement automatic enrollment (where anyone earning more than £7,475 must enroll into a pension scheme of some kind) and switching to retail price indexing from consumer price indexing as the legal minimum for pension indexation.
The list goes on, but what appears plain is that early retirement is more elusive than ever – except for hedge fund managers. The report noted that hedgies are among the key beneficiaries of pensions’ moving toward increased diversification in order to boost returns and mitigate risk.