The elephant in the room

Antony Barker, Chief Pensions Officer at Santander Bank in the UK.

Word from Antony Barker, Chief Pensions Officer at Santander Bank in the UK, is that the elephant in the room when it comes to funding for retirement is not so much the obvious — increased life expectancy (longevity) — but life expectation. It is more a lifestyle crisis than a crisis of longevity.

Barker, along with leading fellow fiduciaries from around the globe, was speaking at the 2016 Sanlam Investments Institutional Insights conference in Johannesburg last week. Key to all the presentations was how to drive better outcomes for members through innovation.

“Pensions used to be for close-to-death savings, but now pensions have to finance a whole bucket list of experiences over many years,” said Barker. “The trouble is, returns have been bad and expectations have not been met, particularly since retirees are likely to spend more of their lives not working than working.”

Barker went on to make the case for retirement fund trustees having to reconsider traditional models of investing and find better ways to meet their fiduciary responsibilities. Old-fashioned “defined contribution” plans needed to be changed if they continued to model their outcomes on traditional asset classes only.

So what is the alternative solution for DC pension funds?

Barker’s solution may appear radical to many — he advocates constructing portfolios using direct investment in private equity, infrastructure and hedge funds. He argued that “legacy pension funds” had failed to keep their promises, either to new members or those receiving pensions. The main reason for this, he said, was that few asset managers were able to demonstrate consistent performance and skilful risk management using standard stocks, bonds, cash and property.

“We need to create vehicles to channel funds into new opportunities — it’s all about diversity. Why should we exclude anything? Capital growth, high returns and yield can be found anywhere in the world if you are prepared to take a long-term view.” Asset allocation really does count…

Barker acknowledged that few retirement fund contributors were prepared to take personal responsibility for their savings — particularly millennials, who typically viewed pensions as boring and showed little interest in accumulating wealth.

“We need to get past the ‘blame game’. There’s only ever one person responsible for your retirement, and that’s you”.

“People have a poor understanding of concepts such as compounding returns and costs. They think a little goes a long way. Meeting retirement expectations requires a lot more saving than people think, but the trouble is they’re not interested. To them, investment is like crystal-ball gazing, it might as well be alchemy.”

The situation is made worse, Barker said, because while returns and inflation may have fallen, traditional asset management fees have not.

The result of this situation has been that investors have abdicated their responsibility to their employers. In turn, employers (via their fiduciaries) have tended to take the easiest option by herding investors into one-size-fits-all default strategies.

Default strategies

“Default is the single most important issue in the pensions industry,” said Barker.

Defaults were introduced for three reasons: to overcome the cost of retirement (and advice fees) 2) to counter irrational behaviour, such as self-delusion, and get fund members to focus on the long term 3) people see safety in numbers “herding”. The default strategy also transferred responsibility from the individual to the fiduciary, to guide decision-making.
Central to its poor suitability to many people is that a default strategy plays it safe, ignoring alternative asset classes and sticking to underperforming “traditional’ investment vehicles.
Barker said that Australia, of all places, had taken the lead over the past decade by pouring investment into “other” asset classes that include private equity, real estate and hedge funds.

Time is money

“There is still the perception that ‘other’ assets are illiquid, and hence more risky. I would argue that having to hold for the long term translates into lower risk. Liquidity is not necessarily a good proxy for risk. If you hold for 20 years or more, vacillations in the market don’t matter.”

Barker added that earning so-called “bulk returns” from alternative investments removed the necessity for funds to depend on the risk-free rate to finance its distributions.

Another benefit of long-term investment is that there is little evidence that tactical switches between asset classes, or within asset classes, provided better returns. “Is it luck or skill? We don’t know when choosing a fund manager,” said Barker.

Since it has been proved that historical performance has no bearing on future returns, too many people have been suckered into believing that track records matter. It is high time, said Barker, that trustees (and, indeed, individual contributors) open their eyes to new ways of doing things.

“If you can meet with triumph and disaster and treat those two imposters just the same” Rudyard Kipling [1895]