2018 has been a tumultuous year for investors. Although economic figures have been strong for most of the year, geopolitical events have created much uncertainty and turmoil in the capital markets. However, in crisis there is always opportunity and in particular, it is more constructive to look forward than to regret the past. Given that lens, these are the two topics that institutional investors around the world need to know in the coming year.
The first is pensions. Worldwide, governments, companies, and individuals have come to the realization that increases in longevity have placed tremendous strain on existing pension systems. Many countries use age 65 as a common retirement age, but that was a number that was first utilized over 80 years ago, and it was selected because the average life expectancy at the time was well below that. For example, in the United States, when Social Security was introduced in 1935 with age 65 as a retirement age, the life expectancy was only 61.
As a result, many countries have begun initiating policy reforms to existing pension regulations, while employers have shifted savings and investment risks onto the employees with the shift from traditional defined benefit plans to individual defined contribution plans. To address this growing gap, institutional investors will have an important role to play. They need to keep up with changing regulations designed to address the pension crisis, and they will need to tailor their investment strategies to be able to deliver the returns needed for an ever-increasing timeframe.
The good news is that current demographic trends and awareness of the pension crisis should result in continued growth in pension assets as governments realize they need more funds to shore up existing systems and individuals realize that they need to save more on their own in order to prepare for their own future. Institutional investors will be looked upon to truly be responsible and responsive stewards of people’s future income.
The second big topic institutional investors need to focus on is that of ESG (environmental, social and governance) investing. A topic that was once niche is now well into the mainstream, and again, a topic that is truly global in nature. Many of the world’s largest pension funds, from the Nordic countries to East Asia have explicitly stated that they will use ESG considerations in their investment strategies.
"Geopolitical concerns and market worries will always exist, but for institutional investors looking towards their long-term strategy, pensions and ESG investing provide two large opportunities for continued growth in the years ahead."
In addition, the rising generation of millennials have proven to be much more conscious and conscientious in terms of how their savings, investments and wealth are deployed. Asset owners such as sovereign wealth funds, pension funds and endowments, whom invest on behalf of their constituents understand the responsibility of that stewardship and thus have been more vocal about these issues. It makes a lot of sense–as ultra long-term investors, they have a vested fiduciary interest that the companies they invest in are growing in a sustainable manner. In fact, Canada Pension Plan Investment Board (CPPIB) became the first pension fund in the world to issue green bonds this past June.
Many asset managers have already responded by tailoring new products to meet this growing demand–one need only scan the headlines of financial news sites to see the proliferation of new “ESG index ETFs” and “sustainable-investing ETFs”. There are some challenges, however. The two key ones are 1) defining “good” ESG practices, and 2) measuring ESG compliance. The environmental aspect is perhaps the easiest in a sense–carbon emissions, pollution, etc.–these are all things that can be measured and quantified. With governance, it becomes trickier. While there are certainly some commonly accepted ideas involving best practices, measurement of governance can be harder to track. Lastly, the ‘S’–social measures are the least well defined and also can vary depending on geographical and regional perspectives. What is required is a common framework so that there can be an agreed-upon framework to be able to evaluate these metrics.
Geopolitical concerns and market worries will always exist, but for institutional investors looking towards their long-term strategy, pensions and ESG investing provide two large opportunities for continued growth in the years ahead. Perhaps it is possible to do well by doing good.