The markets crashed this week, so it’s only a matter of time before juicy headlines start popping up on (social) media eager to pour fuel on the fire. But I have to admit, I didn’t quite see this one from Dutch newspaper De Telegraaf coming: “Pension funds tremble amid stock market turmoil.”
So, thanks for that—it gave me an immediate reason to write this column.
An expensive business
The reason I wasn’t expecting such an attention-grabbing headline is mostly personal. I tend to view the pension industry as a rather opaque little world of insiders, board members, consultants, and opportunists constantly handing each other new jobs and positions. In my opinion, that’s also one of the main reasons why the system has to be overhauled every few years.
On top of the fact that cutbacks are, of course, inevitable—because far too generous plans were handed out in the past. My guess is that pensions are secretly a very expensive business, especially since all the people involved obviously need to be (generously) paid as well.
Coverage ratio
In any case, headlines like the one above always pop up whenever stocks take a hit. At the heart of the De Telegraaf article is the so-called pension compensation, which is now under threat because falling stock prices negatively impact the coverage ratio of pension funds. And wouldn’t you know it—that compensation, which is meant for participants negatively affected by the new system, just so happens to depend on that same coverage ratio.
For funds like PMT (Metal and Technology Industry Pension Fund) and PFZW (Care and Welfare Pension Fund), the situation was already precarious before the recent stock market decline, according to De Telegraaf. Based on their own figures, we’re talking over four million (!) participants combined.
But what if I told you that stocks aren’t the problem at all? Over the past twenty years, equities have delivered an average return of 8.4 percent. And that’s including the recent correction. I can assure you—that’s more than most pension fund asset allocators dared to put on paper.
The real structural issue lies with so-called safe bonds. Over the past twenty years, they’ve barely returned 2 percent annually. And over the past ten years? Practically nothing. Meanwhile, inflation during both periods ran well above those 2 percent. I’ll keep quiet about indexation for now.
A missed opportunity
I suspect few pension funds assumed a structural bond return that would fall below inflation. And that’s a shame, because it means that during the accumulation phase—which in my view gets far too little attention—opportunities were missed. And it’s not even that difficult to reason that interest rates would continue to decline in a debt-driven economy.
Surely pension funds haven’t missed the fact that more and more debt is required just to keep our economies growing? And that this raises serious questions about debt sustainability?
Thinking further ahead
Lastly, here’s a totally random hypothetical. Suppose you’d made a little room in your portfolio, beyond the traditional 60-40 allocation, for that other asset class with a long history and proven diversification benefit: gold.
With just 10 percent of your portfolio in gold—meaning 30 percent in bonds instead of 40—you would’ve earned over 1 percent more annually over the past twenty years. That may not sound like much, but over two decades it translates to a portfolio that’s 21 percent larger than the classic 60-40 split.
And since you’re still investing 60 percent in equities in both cases, that advantage doesn’t just vanish in a stock market crash. The result? A higher coverage ratio, and therefore more room to compensate participants for the negative effects of yet another new pension system.
Jeroen Blokland analyzes striking, timely charts on financial markets and the macroeconomy in his newsletter The Market Routine. He also manages the Blokland Smart Multi-Asset Fund, a fund that invests in equities, gold, and bitcoin.