New concerns arise for asset owners, but an old one never left

Asset owners will have some relatively new worries in 2015 — geopolitical risk, oil-price declines and the impact of changes in mortality tables on funding — but there’s also a familiar concern revolving around interest rates.

“Ask the people you spoke with last year; they said rising interest rates would be a concern,” said Roland Lescure, executive vice president and chief investment officer of the C$214.7 billion (US$186.2 billion) Caisse de Depot et Placement du Quebec, Montreal. “They did rise but not as much as they were expected to. It’s still a concern going into the new year. Interest rates are very important for us long term as portfolio managers and pension funds. Is it a bigger risk than before? I’m not sure.”

Dhvani Shah, CIO of the $34.2 billion Illinois Municipal Retirement Fund, Oak Brook, agreed. “With a backdrop of lower interest rates, the impacts of eventual higher rates on a variety of asset classes are interesting,” Ms. Shah said. “Where you are on the yield curve will be important. Infrastructure, real assets, rate protection all will be important.”

The economy will continue to be driven by central bank activity, said Gregory T. Williamson, director, trust investments, and chief investment officer at BP America Inc., Chicago. BP America has $7.78 billion in U.S. defined benefit assets. “If the U.S. sees strong employment and if we see a rise in inflation, the (Federal Reserve) will see if rates should be increased, at the earliest by the middle of the year. The impact of that will be on our rate-of-return assumption and valuation of liabilities.”

Adrian Orr, Auckland-based CEO of the NZ$27.1 billion (US$20.8 billion) New Zealand Superannuation Fund, said institutional investors are facing “some real tough air pockets” over the coming 12 months that will make it hard to add significant value to investment portfolios. That will “force us to work a lot harder with regard to our active strategies,” Mr. Orr said.

There has been increased concern of late about the potential investment impacts in 2015 from plunging energy prices and from political changes around the world. William Atwood, executive director of the $14.8 billion Illinois State Board of Investment, Chicago, was more worried about global politics. “What’s scary is geopolitical risk,” Mr. Atwood said. “The Ukraine, the Mideast have the risk of running off the rails. And if that happens, there’s nowhere to hide. The negative shocks will affect everyone.”

Mr. Williamson highlighted Russia, the Mideast and the spread of terrorism as risks that could impact investments. “There are enough things to concern investors,” Mr. Williamson said. “The U.S. and Canada are in a position of strength. Europe is in recession, except perhaps Germany, and it’s yet to be determined if the European Central Bank can do something about it. In Asia, China and Japan are trying to engender any inflation it can. Generally, we don’t know globally what will happen. The U.S. economy is a lot more stable and strong.”

Added Ms. Shah: “This is a global economy. What’s happening around the world and its impact on investments keep me up at night.” Slow growth in China and a recession in Japan all “serve as a drag on growth in the global economy,” she said.

Caisse’s Mr. Lescure said geopolitical risk is being viewed “more locally than globally, and by that we mean regionally.” He said Caisse has a few emerging markets identified as priorities for investment, including Mexico and India. “To be frank, we don’t look at Russia,” he said. “It’s very cheap and can get cheaper, but we don’t like the politics and the threat of confiscation there.”

The “big, global, macro correlations aren’t there anymore,” added Mr. Orr at the New Zealand fund. Emerging markets will increasingly demand more of a country-by-country focus, as those countries face the “middle-income trap” challenge of transitioning to doing better things from “copying what was done and doing it more cheaply.”

Investment decisions will be strongly affected by oil prices continuing their free fall in 2015, and how that decline will impact oil-producing nations as well as the introduction of new energy sources to replace more costly fossil fuels. “The big issue impacting the global economy, what really drives currency valuation and inflation, is the energy market,” said BP’s Mr. Williamson. “Whatever happens in energy will certainly impact the global economy. … There are interesting bets being made by investors as to where oil is going.”

On the domestic front, however, the fall in energy prices can be good for investment going forward, said Mr. Atwood of the Illinois State Board. “The reduced price of oil helps the entire economy except the energy sector,” he said. “It also ameliorates pricing pressure. Any way you cut it, it’s good for investing.”

Mr. Orr said U.S. equities — a “major source of our value-added” in recent years — are back around fair value; European and emerging markets stocks appear to offer good value now, but New Zealand Super’s team is less confident that mean reversion will allow the fund to harvest that value anytime soon, he said.

Mr. Williamson said the U.S. will be a target destination for global capital in the coming year. “For institutional investors globally, it’ll be a difficult year. In the U.S., it could be a reasonably good year,” he said.

Within individual asset classes, Ms. Shah said, “the story of the haves and the have-nots will continue in 2015, driving opportunity and risk. There will be greater divergence of returns in subasset classes. On a broader trend, commercial real estate looks strong, but in the subsectors, some are doing better than others. Commercial real estate has recovered in most markets, but not all, such as commercial real estate in the suburbs. Core real estate prices are really high, so it’s good to sell, but you hope your managers have pricing discipline when they are buying core properties in this market since foreign investors have tremendous interest in U.S. core property.”

Also affecting pension fund investments in the new year will be new mortality tables by the Society of Actuaries to be implemented in 2015, said Mr. Williamson, which could reduce funded status by 4% to 10%, “just on the change in tables.”

“Plan sponsors who have gone through a period of beneficial market returns are going to be impacted by the new tables, particularly their projected benefit obligations,” Mr. Williamson said. “Plan sponsors will have to wrestle with those changes and how their investments will have to adapt. The concentration will be on their beneficiaries but they’ll also need to take into account the company’s position. The issue of risk transfer will be how to lower funding volatility to meet obligations but also to look at the balance sheet implications of the pension plans and also the cost” of running plans.

Reporter Douglas Appell contributed to this story.