Investment Diversification is the Key

As an adviser during the early years of this century, the fashionable thing wasbuy to let”.

Convincing sceptical clients to put money in pensions rather than the single asset of property was challenging.

Everyone knew someone who was making money from renting to students or young professionals.  Maybe it is time to remind my clients, and others, that it ended in financial disaster for many.

Every study of investment outcomes concludes that diversification works.

The following article, produced by Technical Connections further demonstrates the point.

Jan


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OECD: INVESTMENT DIVERSIFICATION KEY TO FUTURE PENSION FUND SOLVENCY
Synopsis: Investment diversification key to future pension fund solvency, says expert, as OECD warns on low interest rates.

Date posted: Friday, July 03, 2015

Pension funds and life insurance companies risk long-term threats to their financial viability as historically low interest rates drive them to seek out riskier investments that promise higher yields, according to a new report.

Economists at the Paris-based Organisation for Economic Cooperation and Development (OECD) said that monitoring firms’ activity to prevent excessive “search for yield” at the expense of effective risk management should be a priority for national regulators and policymakers.

“Generating the resources needed to confront the challenge of ageing populations will require a better global allocation of resources to the most productive investments but without excessive risk-taking,” said Angel Gurría, OECD secretary-general. “Above all, much remains to be done to strengthen the ability of the financial system to absorb shocks and avoid the bubbles and busts of recent decades.”

However, pensions expert Robin Ellison of Pinsent Masons, said that investing in a wider range of assets was a much less riskier move for firms than increasing their stakes in traditionally secure, but underperforming, investments such as bonds.

“The OECD, like many regulators in the past, profoundly misunderstands what is risky,” he said. “There is probably much less risk for trustees, employers and scheme members if investments backing their pensions are placed in a wide variety of alternative investments such as cash, infrastructure, agriculture, property, energy and others. The inherent risk is managed by diversification and is very much less than there is in investing in equities and bonds. The challenge (for regulators was to) face up to the changing investment landscape and avoid imposing rules that involve consumers being forced to invest in outdated asset classes”.

Historically low interest rates and the ‘quantitative easing’ and asset purchase schemes that have operated in territories including the UK, US, EU and Japan since the 2008 financial crisis have pushed up the price of bonds, resulting in returns falling as a percentage of the price. This poses particular problems for pension funds, which typically invest around 40% or more of their assets in these types of securities. Lower bond yields and long-term interest rates also affect the calculations used by actuaries when calculating scheme liabilities during their regular valuations.

The OECD’s report, which is the first of what is expected to be an annual publication, said that some funds and insurers could struggle to meet their liabilities to beneficiaries without adjusting their policies, for example by offering lower guaranteed returns on new contracts to reduce liabilities or adjusting or terminating existing plans. However, some would respond by making riskier, higher-yielding investments. The OECD said that there was not yet much evidence that this was happening, but data from the UK in particular already showed a clear upward trend in this type of investment.

The report also warned that the current trend amongst companies to return cash to their investors via dividends and buybacks in order to boost short-term returns meant that this capital would not then be reinvested, hurting innovative investment and productivity growth. The OECD also considered the rise of so-called ‘shadow’ banking and the impact of post-crisis financial reforms on the markets, warning that more needed to be done to ensure that risks were adequately priced and the system set up to absorb future financial shocks.

 

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