By Victoria Butanu
Following a significant increase in assets from 2008 to 2019, pension funds have been hit by the COVID-19 pandemic with experts warning that the ascending trend of previous years may now be reversed. It might take at least three to four years for pension funds to see gains return to pre-pandemic levels, they note.
Pre-pandemic evolution
A report on pension funds published by the Organization for Economic Cooperation and Development (OECD) shows that in 2019 the value of pension funds amounted to USD 32.3 trillion in the OECD area and USD 0.7 trillion in 29 other reporting jurisdictions. The largest amount of assets in pension funds – USD 18.8 trillion – was reported by the USA at the end of 2019. The United Kingdom ranked second with USD 3.6 trillion, followed by Australia with USD 1.8 trillion, the Netherlands with USD 1.7 trillion, Canada with USD 1.5 trillion, Japan with USD 1.4 trillion, and Switzerland with USD 1.0 trillion. These seven countries held over 90% of all pension fund assets in the OECD area. Meanwhile, the Euro area’s pension fund assets have almost doubled in size since 2008, with the total currently amounting to approximately €3 trillion and almost doubling the percentage relative to the Euro area GDP from 13% in 2008 to 25% in 2019.
COVID-19 impact
However, the OECD report noted that the impacts of COVID-19 were set to reverse some of these gains with the consequences having had an effect on financial markets during the first quarter of 2020.
- Whatever had been gained as a result of strong investment returns in 2019 was then lost with an estimated 8% drop compared to the end of 2019.
- The decline in equity markets is generally considered to be the main factor contributing to this fall. Returns, inclusive of dividends and price appreciation, were negative on the MSCI World Index in the first quarter of 2020 (-20%), and between -11% and -24% on the MSCI Index for Australia, Canada, Japan, the Netherlands, Switzerland, the United Kingdom, and the United States.
- Decreased interest rates may cause a spike in the price of government bonds in the portfolios of pension funds as the gains of newly issued bonds fall.
Because investments for future retirement are generally made over a long period of time, there is every chance that any current financial losses will be recovered over the coming years so it is important not to withdraw assets prematurely.
Repairing the damage
As painful as the damage caused by the ramifications of the pandemic is, it is important to note that the current decline is not nearly as bad as that which pension funds and the world economy at large experienced as a result of the 2008 global financial crisis.
According to JP Morgan’s Report Covid-19: Assessing the corporate pension funds allocation, “it will most likely take three-to-four years for investment returns and falls in yields to bring funding levels for the average pension fund back up to December 2019 levels, based on our 2020 Long-Term Capital Market Assumptions”.
However, this scenario may change if further shocks occur before pension funds recover from the losses, they have recently experienced. Should this be the case, obviously it would take longer for the funds to return to 2019 levels.
These estimates are for the average fund but less mature funds carry more investment risk which makes them more susceptible to the type of market changes currently being experienced and this will mean a greater setback to long-term funding. While mature funds are considered to be generally more stable and thus will suffer less, JP Morgan reports that these have been affected too.
“Many of the funds in this category have been hit by operational and liquidity challenges in the crisis, particularly those that use substantial leverage to hedge liabilities (in March, the spike in interest rates caused substantial collateral movements), use currency hedging or maintain substantial allocations to private market assets where striking valuations has been difficult. No doubt, mature funds will be refining their strategies as they reflect on the experience and lessons learnt through the crisis.”
Many governments across the world are making efforts to support their economies. Certain Central Banks, such as the US Federal Reserve, have already cut interest rates to alleviate losses.
The recession caused by COVID-19 closes the latest market cycle. This means that now is the time to use this opportunity to improve investment strategies. “We would expect hedgers to shift from hedging interest rates through derivatives to hedging with physical instruments, and to further diversify their range of income sources to service and stabilize cash flows”, concludes the JP Morgan analysis.
