Pension funds urged to ‘keep calm and diversify’ in crisis
Trustees should not react impulsively to market turbulence
Trustees should remain calm in periods of market volatility and concentrate on their balance sheets rather than reacting to bad news, despite falling funding levels, according to J.P. Morgan Asset Management.
Equity markets have experienced significant volatility since the end of July, with the FTSE 100 falling from near 6,000 points to below 5,000 and hovering around the 5,200-5,300 mark since then. Corporate bond yields have been reasonably stable over this period, but credit spreads have risen in response to increased market uncertainty.
According to Paul Sweeting, European head of J.P. Morgan Asset Management’s strategy group, the typical UK pensions plan will have seen its funding ratio – the value of assets versus liabilities – fall from 93% at the end of March to around 85% at the beginning of August.
He said: “It is understandable that market volatility causes significant concern for pension schemes but the current market moves highlight the importance of diversifying return-producing assets rather than focusing on short term fluctuations.
“Within equities, it is important to diversify across a range of markets, including emerging markets; and it is important to consider exposure to other sources of return, such as commodities, infrastructure and areas such as insurance-linked securities.”
Assumptions made using conventional asset allocation models about the ‘normal’ returns can be problematic in reality, according to a recent paper by J.P. Morgan Asset Management, which demonstrates a greater need to diversify investment portfolios.
The main assumptions are that returns are independent from period to period, that returns are normally distributed and that correlation relationships do not change. The paper says these assumptions are incorrect, especially in times of increased market volatility.
Sweeting added: “Whilst it is difficult for pension schemes to determine the direction of the market on a day to day basis, markets do tend to move through cycles of higher and lower volatility – and at the moment we are in a period of higher volatility.”