By Neil Behrmann
September 2010 It is virtually a repeat of the bear market of 2001 to 2003. Numerous pension funds have been selling equities and placing the money in bonds and so called alternative investments.
The drip, drip pension sales of equities proved to be wrong some seven to eight years ago and could well be a mistake again. Pensions were selling at the bottom in 2002 and early 2003 when that bear market ended, within days of the invasion of Iraq. They continued to sell as the market recovered. By the time global stock markets were much higher in 2006 to 2007, stocks were once again their favourite investment. Similarly pensions have been consistent sellers of shares in the post crash recovery of 2009 and 2010, even though the vast majority offer better value than bonds.
Similarly to the post 2001 to 2003 bear market, the current mantra of pension fund managers is asset liability management. This, in essence, is diversification of assets at a good return to minimise risk. The game plan is that the fund appreciates with minimum risk. The hope is that the pension will then have adequate assets to fund expected future payments for the growing number of pensioners.
The depressing déjà vu of equity sales comes at a time when cash pays virtually zero interest, ten year US Treasury bonds are yielding a miserly 2.55 per cent and investment grade corporate bond returns only 4 per cent. Some pension money is going into commercial property which has generally performed abysmally in the past few years and some into hedge and private equity funds which haven’t done well either. A small portion has landed in commodities and that investment tactic has mainly yielded unimpressive, if not poor results in the past year.
A recent survey showed that about a third of some 250 corporate and public pension funds have decided to cut their equity holdings. Surveys in the UK and Europe have received a similar response. The Towers Watson study estimated that equities accounted for between 50 to 60 percent of total assets in 2009 but anecdotal reports indicate that the proportion has shrunk even further.
Underfunded pensions crisis
There are various estimates of underfunded pensions. In the US alone the gap between pension assets and liabilities is more than $1 trillion , estimates Pew Center, a non profit organization that wishes to improve public policy and slash the pensions deficit. Pension fund managers and their trustees have, unsurprisingly, become terrified of volatile markets. These market gyrations in mainly sideways markets since September 2009, have ironically arisen from trading of desperate hedge funds. They have been whipsawed, trying to achieve the hopeless objective of performing month by month to meet demands of their silly, greedy investors. In survey after survey during the northern hemisphere summer, pension fund and hedge managers have been bearish. In contrast private bankers narrate that their wealthy cash rich clients were selective buyers of stocks on a medium to longer term view. The sharp rally in global markets in the past fortnight, shows so far, who is right.
Equity values surpass bonds and commodities
Decisive and shrewd pension fund investment decisions are vital in coming years because of aging baby boomers and the health of equity markets and the global economy. Pension funds in some 13 nations control portfolios worth around $23 trillion, according to a survey of Towers Watson earlier this year. This dwarfs the estimated $1.5 trillion in sovereign wealth funds. Back in the early years of this decade when equity markets were depressed, earnings yields ( inverse of the price earnings ratio) and dividend yields were higher than bond yields. The difference between equity yields and bond yields of around 2.6 per cent for ten year US treasuries and 3.8 per cent for 30 year bonds, has widened even further. Take as an example some market averages: US S&P 500 has an earnings yield of 6.7 per cent and dividend yield of 2.5 per cent; the UK 6.8 percent earnings yield and 2.9 per cent dividend; Germany, 6.7 per cent and 2.7 per cent dividend; France earnings yield 6.5 per cent and 3.5 per cent dividend yield; Japan Topix, 6.5 per cent earnings yield and 2 per cent dividend yield; Singapore, 6.4 per cent earnings yield and 2.7 per cent dividend while Hong Kong has achieved a 7.2 per cent earnings yield and 2.6 per cent dividend.
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