Insights

Opinion: David O’Shea on the importance of understanding what lies beneath each investment opportunity

30th March 2020

Reinvestment risk is the single most significant threat facing pension investors today. While the past decade has seen the strongest bond and equity market gains on record, what investors are grappling with now is: 

Where to invest next?

The past decade has been characterised by an abundance of investment returns. From 2009-2019 is the longest uninterrupted period of asset growth in history. Since June 2019, equities using American benchmark, S&P 500 index rallied by around 300% using Eurostoxx600 as a European benchmark, they rallied by around 170%.

Take a journey back to 2009. Barack Obama is inaugurated as US President, the iPhone 3 is launched and Oasis finally broke up. You could invest in a 10-year Government Bond which provided an annual return of c.5% plus a guarantee of your money back. You could buy Apple shares $25 (today you can sell them for €227, a 700% return). Even if you invested in a general basket of equities, you could expect an annual dividend yield of 7%, more than enough to compensate you for some expected periods of market volatility. In most cases, investors enjoyed both strong yields/dividends and price appreciation as equity market investments more than doubled investor returns.

Those halcyon days were of course immediately preceded and triggered by the global financial crisis (2007-2009). With markets and confidence in freefall, sovereign entities stepped into the breech. They began a multi-year process of accommodative monetary policy, by slashing interest rates and printing money. The aim was to support a battered financial system and repair household and corporate balance sheets. It was the perfect tailwind for risk assets.

Fast-forward a decade to 2019. Today you can invest in a 10-year government bond that will pay you 0% interest and unfortunately, for you it will guarantee to pay you back less than you invest. If you invest in a basket of equites you can expect a meagre 2% annual dividend but also lots of market volatility. This is a topsy-turvy world barely recognisable from 10 years previous.

Today, on a risk-adjusted basis, neither bonds nor equites provide pension investors with much attractive qualities in 2019. Actually, they don’t make much sense at all. Practically, what this means for pension investors is that those who have enjoyed stellar returns form the past decade are now facing a world where returns – and importantly, risk adjusted returns – are extremely low. In some cases, they are negative. Pension investors can no longer plan for a steady 5% growth return offered previously. The risk of reinvesting your pensions funds, or any capital, has risen exponentially. Even Warren Buffet bemoans the lack of opportunity or return.

Global pension funds and managers face another more fundamental challenge. These large global institutions typically manage assets in the aggregate: they invest different percentages in bonds or equites to provide balance and diversification. Against the backdrop of current bond and equity dynamics, this has gotten significantly more difficult.

Against this backdrop of a drying well of returns, a subtle movement in investing has been occurring, and that is the importance of socially responsible investing. 2009 was pivotal in not only signalling the end of the financial crisis, but it was also the genesis of what is today known as social orientated investing. In 2009 GM went bankrupt, ushering in a decade of losses and consolidation for the fossil-heavy motor industry; Nissan launched its electric Leaf car; C02 emission were regulated, and Obama assembled a Green Cabinet. Nissan launched their Electric Leaf.

The world is pivoting, and pension investors have to change to ensure they keep their portfolios in real peak condition. They can only do this only by focusing on achieving real diversification and targeting real return – not the ones that are forecast based on a different time.

The heady days of sovereign states of coming to the rescue of investors in bonds and equities, by providing a good-sized return annually, now seem an eternity ago. Added to that well drying up are the difficulties now facing aggregated investments in bonds and investing. 

Focus on reinvestment risk. Think macro; act micro. Focus on Infrastructure and impact opportunities. Get your pension provider to drop their fees and your investment manager to up their game. 

Think about what lies beneath each opportunity.