Pension Funds, Risk Allocation and Alternative Investments

Pension Funds, Risk Allocation
and Alternative Investments
prof.dr. S. van Wijnbergen
University of Amsterdam
[email protected]
Average Implied Volatility STOXX50
24 months to maturity options
Very aggressive unconventional monetary
policies on both sides of the Atlantic
Moeten we ons zorgen maken over inflatie?
Overwegingen bij Pensionsystem Redesign-1
Hogere pensioenleeftijd onvermijdelijk
– Regeerakkoord voorstellen grote stap id goede richting
• gradueel 65=>67
• daarna koppeling aan demografie
get ready for a more volatile world
– onvoorwaardelijke garanties bestaan niet
risk sharing: waarom risico’s delen, en met wie?
– habit formation, inflexible spending components
– risk pooling
welke schokken kunnen door delen afgevlakt worden?
– demografie veranderingen zijn voor iedereen en permanent
– inflatie heeft veel mean reversion (ECB credibility, Monetary policy
– Fin mkts have some LT mean reversion
=> Deel financieel, inflatierisico intertemporeel (uitsmeren)
=> demografische schokken snel verwerken
Overwegingen bij Pensionsystem Redesign-2
Risk Sharing VEREIST Intergenerational Fairness:
– groepen moeten niet ex ante (voorspelbaar) beter af zijn buiten
het systeem
STAR akkoord extreem fout: verwacht portefeuille rendement als
discontovoet leidt tot:
• veel te vroege indexatie, ten koste van jongeren
• onbeheersbare prikkels tot risico zoekend gedrag
• “invaren” gaat EVRM problemen geven
• Perverse compensatieregeling AOW
Kamp’s voorstellen steeds meer in de goede richting
Regeerakkoord deels curieus
– waarom aftoppen fiscale faciliering boven 100 kE: onnodige complexiteit
– verlaging pensioenopbouws percentage valse besparing
Investment challenges for retirement
• individual life cycle saving and asset allocation
– who should take risks when?
• intergenerational risk sharing
– when is risk sharing useful?
• Alternative investment opportunities and pension funds
Structured Products
Private Equity
Hedge Funds
regulatory threats
• The future of investing for retirement
Risk Taking and Age: generational accounts
and asset allocation
Young have large human capital, little financial capital
– human capital may rise initially but declines with age and becomes zero
at retirement
So the young should save, but should they also load up on risk in
their financial wealth?
The value of pension funds
– trade on wholesale markets => lower costs/higher pensions
– offer risk sharing possibilities not open to individuals
• over individuals (collective DC)
• over generations (collective DB systems)
– Mandatory participation
• protects individuals against behavioral inconsistencies
• allows insurance markets to function
Should the young take on more risk?
• Yes in general BUT
• Is labor income related to stockmarket returns?
– yes for entrepreneurs…..
– macroeconomics: long term income shares are relatively stable
• variance is in aggregrate growth, not income shares
• Is labor supply flexible enough?
– hours worked & marginal tax rates
– flexible retirement age & L-market for elderly workers
– policy challenges: labor force participation of elderly workers
• productivity and age: some empirical surprises
• Flexibility of spending commitments and risk taking
Pension funds and risk taking for the young
• L-markets are becoming more flexible, marginal tax rates
lower (but this cabinet…) => take more financial risks
early on (or in “young” pension funds)
• Should pension funds play a bigger role in financial
– resist the siren songs of politicians, do not subsidise distressed
banks by buying mortgages above market prices
– reverse mortgages?
– saving for future healthcare through pensions?
The role of alternative investments: some
• Contrary to what the EU commission thinks:
– hedge funds and PE are not the same
– neither played a significant role in the credit crisis
– securitisation did play a role but should not be regulated out of
• Because of these misconceptions, there is a regulatory
threat that will reduce their attractiveness as investment
• But there are problems in all three areas
Regulatory environment:
Trade off: financial stability ~ innovation
• future of structured finance?
– can play a useful role transferring risk from banks to less
leveraged institutions
– needs public market infrastructure?
– impact on corporate governance?
– block abuse by banks
• Regulation more principle based, less rules based?
– do not fight the last war
– Financial innovation always a result of interaction new
investment vehicles and regulatory structure
• Design the regulation not from individual cases up but
from system stability requirements down
– example: countercyclical capital requirement regime
The Future of Structured Finance
SF intended to spread risk out more widely, transfer risk from highly
leveraged banks to less leveraged institutions and so reduce fragility
But SF has been used to mask balance sheet risks in a regulatory arbitrage
SF products often OTC and therefore hard to value
Lack of transparency has increased rather than reduced fragility….
Excessive insurance reduces governance role of debt
Major rating problems as yet unresolved
– both methodological and incentive problems
– need for simpler products
– realise impossibility of fine-mazed risk ratings
SF still necessary, but improve market infrastructure:
– accounting, valuation and reporting standards
– clearing and settlement institutions
The “originate & Distribute” model undermines
the role of debt in Corporate Governance
Leverage and Corporate Governance:
– Equity holders monitor in good times
– Debt holders monitor in bad times
Stricter rules on equity exposure banks to avoid conflict of interest?
Securitization undermines corporate governance role debt holders
– Originator does not care (risk off-loaded)
– New owner typically far removed from individual loans
• because of packaging
• Because of multitude of owners (cf problems US mortgage renegotiations)
• Because of explicit clauses in SIV’s, renegotiation underlying assets difficult
– Securitized subprimes see 20% more default than loans held in portfolio
Solution: allow only partial transfer of risk?
– but how should it be set up (slices thr all tranches, residual equity
Transparency Requirements and the Future
of Hedge Funds
Hedge Funds
– Promise returns uncorrelated with stockmarket or business cycle
– Correct mispricing in asset markets
– Provide liquidity for trade in underpriced assets in good times
– But withdraw liquidity during crises
Their risk characteristics difficult to assess
– Long term volatility seemingly lower than S&P
– But structure of volatility different: high risk of extreme events
– Selling beta-risk after all? So are managers claiming alpha vastly overpaid?
Transparency requirements fundamentally at variance with their modus operandi
– Advertising mis-pricing may make it disappear
– Should they report highly concentrated exposures to their investors?
Will they too turn into traditional mutual funds?
– No need to regulate as long as there are no retail investors
– Movement to take HFs public highly irresponsible
Regulating hedge funds out of existence will not stop arbitrage activities, Banks will
do them “in house”?
Benefits to PFs not clear, difficult to fit in because of tail risks, lack of transparency
Private Equity mired in controversy
Promised to resolve governance problems
– one dominant investor with LT horizon
– particularly useful in corporate restructuring phase
– but governance problems recreated when PE goes public?
Returns mired in controversy
– recent study:
• large discrepancy return on investments ~ returns to investors
• => excessive management fees
• large funds provide premium to S&P index to investors, small PE funds don’t
– Other studies do find a liquidity premium (is NOT alpha => management
pay still excessive)
Can play a role for PFs, they have easier liquidity planning
– but select funds carefully, focus on large players?
– pay attention to management fees
Risk, Pension Funds and retirement Savings
Pension funds are irreplaceable tools for private risk management over
the life Cycle
– creeping roll back of collective PFs in “regeerakkoord” unfortunate
Generational accounts in PFs can help
– individuals rationalise intertemporal allocation of risk
– while maintaining benefits of collective market access
– but keep DB elements for intergenerational risk sharing
• financial risk MUCH more important than inflation risk in Dutch environment
Liquidity premia PE opportunity for PFs
– but careful selection necessary
Structured products allow PFs to remedy funding gap in banks
– IF incentive, valuation and regulatory problems SF can be resolved
– resist moneygrabs politicians eager to rescue banks