U.K. conference highlights a variety of certainties

A number of certainties were clear at this year's Pensions and Lifetime Savings Association investment conference: that climate change is a very real risk; that growth is and will remain hard to come by; and that innovation and disruption are lacking in the money management and retirement industries.

The association's annual investment conference, which took place in Edinburgh, March 9-11, this year opted for “creating certainty in an uncertain world” as its theme. Over the three days, delegates heard from industry experts on a number of topics, including the Financial Conduct Authority's study into where the money management and consulting markets are failing pension funds; the upcoming referendum on the U.K.'s future standing as part of the European Union; and how to cope in a crisis, from none other than Yanis Varoufakis, Greece's former minister of finance,.

But one thread ran through many of the conversations, despite only one session being devoted to the topic: climate change.

“Paradoxically, institutional investors are certainly the largest investment sector, but you are, (in) comparison to the size, the least engaged in climate finance,” said Christiana Figueres, executive secretary, United Nations Framework Convention on Climate Change, in a panel titled “The climate challenge: investing for tomorrow's pensioners.”

“I am here to ring a bell of alarm for you, and to tell you frankly that (you) can, should and must change. Because of the risk — because of the risk to the global economy, that's why.”

Ms. Figueres said that institutional investors, as long-term, investors, “are the best positioned to make a choice as to what kind of infrastructure we are going to build in the next five to 10 years: You play an extraordinary role in stabilizing the economy over the long-term — and I'm sure you are aware of the fact that central banks, who usually play that role complementing yours, have actually run out of ammunition. They have reduced interest rates to the point where some of them are paying negative interest rates. What kind of financial world do we live in that we now have (that)?”

Ms. Figueres said climate change carries a huge financial risk, and said high-carbon assets should carry a warning label similar to that on tobacco products, reading: “These investments can be dangerous to your financial health, to your economic health and certainly to the world.”

She hit home the role that institutional investors have to play in alleviating climate change risk by telling delegates there is “a huge, huge opportunity for you to be playing your role in history, to your own advantage.”

One highlight from the conference was a panel of retirement plan executives discussing what keeps them awake at night. While the issue of low interest rates came up throughout the conference, this discussion also addressed the lack of growth.

“From a pension fund perspective we have never had to work harder to identify other … sources of growth,” said Faith Ward, chief risk officer at the £2.7 billion ($3.8 billion) Environment Agency Pension Fund, Bristol, England. “The long-term prospects for growth globally are very lackluster, and therefore we are having to work really hard.”

Panelists considered increased allocations to alternative credit, such as private markets. “Low interest rates are causing people to move away from government bonds, which are extremely low yielding, into private markets and loans and all these sorts of alternative credits,” said Mark Fawcett, chief investment officer at the £772 million National Employment Savings Trust, London. “And do people really understand the risks they are taking in those portfolios and in those asset classes? Because for a lot of people (they are) relatively new, and this is traditionally an area where banks would operate, and suddenly pension funds are operating in them, and are trustees clear on what risks they are taking?”

Mr. Fawcett said he considers liquidity a “big cause for concern, but at the same time long-term investors don't need as much liquidity — so on the one hand people go into these very illiquid private markets where they don't necessarily understand what the credit risks are, and then they really want a lot of liquidity in other asset classes and get very worried that liquidity isn't there.”

He said he spoke with a credit manager recently about corporate bonds, who told him that, in his 20 years of experience, liquidity in credit markets has never been as bad as it is now. “But then I asked him, are you being paid for the illiquidity risk? He said 'absolutely — if you are prepared to buy and hold, you are being paid for a risk.'”

Mr. Fawcett said on the one hand, investors understand the mature corporate bond market very well — “that should be potentially an attractive asset class — but people are going into these more opaque asset classes, happy with the illiquidity there, but not happy with the illiquidity in corporate bonds. I think understanding (whether you are) being paid for the risk is important, and understanding where the risks are that you are taking.”

Ms. Ward said the EAPF has “embraced this illiquidity premium,” and has looked into private debt, stepping into the market that is being exited by the banks — but is doing so “cautiously and tentatively.” Executives have also put in place “quite an explicit buy-and-maintain” corporate bond portfolio. “The challenge for pension funds has never been as great to try and keep all of these issues in check and to do a good job,” said Ms. Ward.

New thinking and innovation in investment was carried through to the final day of the conference, with a “balloon debate” considering disruption in the money management industry, featuring Euan Munro, CEO of Aviva Investors.

Mr. Munro considered good disruption and innovation vs. bad disruption and innovation. “I think our industry could do a good job in clarifying objectives of funds — I actually think that describing the risk of a fund without a clear intention of the fund to deliver some kind of outcome is a cop-out,” and said that is “rife” in the money management industry. “We describe things as low, medium and high risk, allowing people to make the shorthand assumption that high risk is going to deliver high return, which it doesn't always.”

He said clarity is needed about the drivers of return and investment solutions; “is it coming from straightforward beta? If it is, I think we should all be worried about those kind of solutions, because beta has been buoyed up by about 25 (to) 30 years of declining interest rates. So if you drop the discount rate on assets that are priced off a discounted claim on future cash flows, asset prices go up — and they are very high at the minute because interest rates are very low. That has been a fantastic tailwind for beta, but maybe won't look so healthy over the next 10 (to) 15 years,” he said.

Another good innovation would be money managers being able to give greater clarity: “a real 360 perspective” on the risks they are running.

For savers, what is needed right now is the “ultimate drawdown fund for people to move into retirement and be confident that they are going to have some income to be able to live in dignity and retirement — very difficult to see how that happens when we have got substantially negative interest rates across swaths of Europe, out as far as eight, nine years on the bond curve. How do you actually generate a decent income?” he said.