Since the emergence of “Modern Portfolio Theory” and the “Capital Asset Pricing Model” in the late 1960s, institutional investors have taken a quantitatively driven approach to portfolio construction, looking to create portfolio diversification and obtain better risk-adjusted returns by balancing their asset-class exposures. This journey has seen several important advancements in thinking about how to optimally achieve desired results.
Funds that want to take the total portfolio approach first need to get the total portfolio view. To do that they not only need data – and lots of it – but a rock-solid understanding of exactly how they’re going to use it.
The state of the pension fund world
The world’s major pension systems enjoyed their strongest year, last year, for growth compared to GDP, since 1998. The bad news, of course, is that the average 11.2 per cent rise for many countries this helped by stalling or falling GDP.
The annual ‘Global Pension Assets Study, 2021’ from the Thinking Ahead Institute based in London, showed particularly strong growth for Australia, which has remained the fifth largest pension market in the world. Australia increased its pension assets from 151 per cent of GDP to 175 per cent, despite losing A$36 billion through the Government’s ‘Early Release Scheme’ measure to ease the impact of COVID-19. It is third in the world on that score behind the Netherlands (214 per cent) and Canada (193 per cent).
The global rise equalled that of 2009, a string year for markets and recovery from the global financial crisis, which was also the highest growth rate since the study began, as a piece of work by Willis Towers Watson. in 1998. The big asset consulting firm later started an in-house ‘Thinking Ahead Group’, in 2002, which subsequently, in 2015, spawned the independent ‘Thinking Ahead Institute’, funded by a group of large institutional investors and managers. It currently has 45 members.
Jessica Melville, the head of strategic advisory investments for Willis Towers Watson, based in Sydney, said of Australia’s performance: “While early release supported members in their time of need during the pandemic, Australian funds have shown considerable resilience and they will continue to play a significant role in the nation’s recovery.
“This will be an interesting year for funds, following the Australian Government becoming a signatory to the Coalition for Climate Resilient Investment. One of the main challenges and opportunities for impact among superannuation funds is the effective stewardship of their assets and a turbo-charged approach to ESG considerations led by climate change and the accelerating path to net zero.
“Funds will continue to draw upon a total portfolio approach to value creation to meet the ever-evolving needs of their stakeholders – members, the wider society and the natural environment.”
The top 22 markets in the world held a combined US$52.5 trillion at the end of last year, which represented an average of 80 per cent of GDP. The top seven account for 92 per cent of this. The average ratio to GDP for the top seven markets was 147 per cent, which was a 20 per cent rise for the year. The study covers 195 markets, but only the top 22 are reported in detail. The additional 173 are thought to add about US$3-5 trillion to total world pension assets.
The research also shows the shift to alternative assets continues, marking two decades of change in pension fund asset allocation globally. In 2000, just 7 per cent of top-seven pension fund assets were allocated to private markets and other alternatives, compared with more than a quarter of assets (26 per cent) in 2020.
This shift comes largely at the expense of equities, down from 60 per cent to 43 per cent, in the period, while bond allocations fell marginally from 31 per cent to 29 per cent. The average top-seven asset allocation is now equities 43 per cent, bonds 29 per cent, alternatives 26 per cent and cash 2 per cent. Australia has the top allocation to equities, at 48 per cent and also, perhaps surprisingly, the top allocation to cash, at 15 per cent.
Defined contribution (DC) assets are now estimated to represent almost 53 per cent of total pension assets in the seven largest pension markets, from 35 per cent in 2000, making it the dominant model for pensions globally. During the last 10 years, DC assets have grown at 8.2 per cent a year, while defined benefit assets have grown at only 4.3 per cent.
Australia continues to have the highest proportion of DC to DB pension assets, with 86 per cent of its total pension assets in DC funds. Conversely, Japan (95 per cent), the Netherlands (94 pr cent), and the UK (81 per cent) continue to be dominated by DB pension assets.
Marisa Hall, co-head of the Thinking Ahead Institute said: “In what was a highly tumultuous year, pension funds continued to grow strongly in 2020, underpinned by ongoing multi-decade themes such as the rotation from equities to alternatives and the growth of DC, now the dominant global pensions model.
“This paints a picture of a resilient industry in good health and relatively well placed to weather the effects – economic and otherwise – of the ongoing pandemic. This is good news for billions of savers around the world.
“However, this shouldn’t mask the growing set of challenges that industry leaders face, particularly around addressing broader stakeholder groups’ needs and wants, while continuing to deliver financial security for their fund members.”
