“In a crowded hall, exit doors are small… ”

This recent RBS research piece (and summary articles in the Guardian and Telegraph) has caught people’s attention; I overheard it mentioned in the coffee queue and on the tube this morning, and it’s certainly been a hot topic of discussion in the team.  It cites a number of reasons why investors should be cautious in the year ahead, including a slowdown in China, the falling oil price and the tightening of monetary conditions by the Fed.

Whilst both the research piece and the articles are designed to grab headlines (with analogies like the above title), two particular parts stood out for me;

  1. Sell everything apart from high quality bonds

This would obviously not be good news for Pension Schemes.  An increase in demand for high quality bonds will push down interest rates, increase the value of liabilities and widen deficits.  Many Schemes that have held off on hedging hoping for an uptick in rates could be disappointed.

  1. This is about return of capital, not return on capital

If the market as a whole rushes into bonds this will weigh heavily on Scheme’s return seeking assets, eroding the capital base. This is not only bad for funding but puts schemes in a weaker position going forwards – for example, a capital loss of 20% in a year on £100, means that you need a return of 25% next year just to get back to where you started.  Clearly it’s better to try and avoid some or all of this loss, but you don’t want to be out of the market to miss the bounce if and when it happens.

The RBS piece makes the assumption that you have to leave the hall – i.e. that it is on fire. I would argue that a 20% fall in asset prices is not really a building burning down, more like a hot concert venue where the air conditioning is broken.  As anybody who has been to a conference or concert knows getting back into the hall afterwards involves a lot of waiting around; often with the risk that you miss the start. If you can find a way to stay inside when everyone else leaves, you will get the best view of the show.


It is just a question of dressing appropriately…..

The same is true of pension schemes facing the potential of turbulent markets. If they can position themselves effectively there is a lot of value that can be extracted from the ability to take a (slightly) longer term view.

Pension Schemes don’t want to be the last to react if they are hoping to time the market but, in reality, they will never be the quickest.  Rather than relying on manager skill (and luck) to time markets, there are more appropriate risk management strategies that Schemes can deploy to stay invested and cope with market volatility.  For example, if Schemes can be confident they are protected against the first 20% of losses on their equity portfolios, they will have a much stronger capital base to deploy to capture any upside when it arrives.

Preserving capital can be done, via protection strategies, that don’t require schemes to time the market and sell assets. Having such a strategy in the portfolio will mean that schemes won’t need to worry about the exit.


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