As a DB scheme, you may have found yourself inadvertently on the rollercoaster ride of volatile markets in recent days. If that’s the case, it’s always worth considering whether you intended to be on this rollercoaster and if not, what other DB pension schemes are doing about it.
Consider strategies that are designed to protect or be less influenced by volatile market conditions
Following the end-May bank holiday global markets were dominated by Italian political developments as the political crisis intensified. Misery loves company as the saying goes and that is definitely the case for crises in Southern Europe – the Spanish prime minister Mariano Rajoy has also left his position following a corruption case involving his party. Though in grand scheme of 2018 risks, these may in fact turn out to be overshadowed by greater market volatility triggered by a China/US trade war, Russian sanctions, Brexit uncertainty, Argentina volatility or a myriad of other geopolitical and broader risks that may surface.
It’s interesting to note the significant market reaction in the UK as the long weekend’s developments were digested (with an understandable focus on Italy). 20-year gilt yields initially fell by almost 20 basis points (bps), FTSE 100 fell 1.5% and EuroStoxx 50 fell 2.5% from their previous day close, although they also all recovered to different degrees in the subsequent days. Given this level of reaction to the weekend’s news, the risks mentioned above could lead to further volatility for investors.
So what are defined benefit pension scheme’s doing to prepare and/or adapt to market volatility? Some of our clients consider strategies that are designed to protect/be less influenced by volatile market conditions, for example:
One of the key drivers of equity options and swaption pricing is the underlying asset’s volatility, so depending on the exact strategy, timescales, levels etc these can be designed and tailored to adapt and capture opportunities of market conditions.
So if you find your DB pension scheme on this rollercoaster of market volatility, perhaps consider whether there may be a place for a more stable ride on the Ferris wheel, or invest in a waterproof to protect you from the unexpected splash that might be round the next corner.
Evolutionary psychology highlights a Stone Age mentality hardwired into our brains and reflected in our behaviour and habits. For example, we tend to organise ourselves into groups in order to adapt more easily to different environments: behaviourally it is far less dangerous to be wrong in a group than to be right on our own. This explains the desire and impulse of an individual investor to follow the crowd.
Traditional models suggest that there is a very high chance equities outperform over the long term. But are they overconfident, and should long-term investors adjust their asset allocation accordingly? Let's consider this question from one particular technical angle.