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The plunge in interest rates since the financial crisis is wreaking havoc on funds

Jan-Pieter Jansen, a 77-year-old retiree from the Netherlands, had high hopes for a worry-free retirement after having saved diligently into a pension during his working life.

But Mr Jansen, a former manager in the metal industry, has been forced to reappraise his plans after receiving notice from his retirement scheme, one of the Netherland’s biggest industry-sector funds, of plans to cut his pension by up to 10 per cent. Understandably, the news has hit like a sledgehammer.

“This is causing me a lot of stress,” says Mr Jansen, who retired 17 years ago and hoped to use his pension pot to treat his grandchildren and afford good hotels on holidays. “The cuts to my pension will mean thousands of euros less that I can spend on the family, and the holidays we like. I’m very angry that this is happening after I saved for so long.”

Mr Jansen is not alone in experiencing pension pain. Tens of millions more pensioners and savers around the world are facing the same retirement insecurity as Mr Jansen, as plunging interest rates since the financial crisis wreak havoc on the funding of schemes. As average life expectancy increases, pensions have become a defining political issue in countries as diverse as Russia, Japan and Brazil.

General Electric, the US industrial conglomerate, recently announced that it is joining a growing list of companies that are ending guaranteed “final salary” style pension schemes, affecting around 20,000 of its employees. In the UK, tens of thousands of university academics are preparing to take strike action over steep rises in their pension contributions.

A common factor in this global pension upheaval has been suppressed bond yields.

Bonds have historically provided a simple match for the cash flows needed to be paid out to the members of retirement schemes such as Mr Jansen’s. But decades of declining bond yields have made it far harder for pension funds to buy an income for their members, pushing them more into equities and other riskier, untraded investments, such as real estate and private equity.

Buoyant financial markets have so far ensured robust investment gains for pension plans on their existing holdings. Yet given their long-term liabilities, the dimming outlook for future gains is causing anguish.

“Their house is on fire,” says Alex Veroude, chief investment officer for the US at Insight Investment, which manages money on behalf of many pension funds. “And rates can and probably will go lower from here. Even if the house is on fire, it’s still only the first floor. We think it can hit the second and third floor as well.”

This is not merely a danger to individuals like Mr Jansen who may see their pensions cut — it could also have a wider impact on the economy. If people set aside more money for retirement, it may hamper economic growth by reducing consumption — the opposite of the intention of central banks when they cut rates. The Swedish Riksbank hinted obliquely at this when it recently signalled it would lift interest rates back to zero by the end of the year, saying that “if negative nominal interest rates are perceived as a more permanent state, the behaviour of agents may change and negative effects may arise.”

There may even be more systemic consequences. Last month the IMF warned in its annual report on global financial stability that the rush by pension funds into “illiquid” assets will hamstring “the traditional role they play in stabilising markets during periods of stress”, as they will have less money available to scoop up bargains.

The push into more unorthodox investment strategies is worrying some in the industry, who warn that they could exacerbate market downturns. “We’re seeing some really unusual behaviour, and we’ll see some payback,” says Con Michalakis, chief investment officer of Statewide, an Australian pension plan. “The trillion dollar question is when? I’ve been doing this for long enough not to want to predict when it will happen.”

When Christopher Ailman studied for a degree in business economics at the University of California in the late 1970s, Federal Reserve chairman Paul Volcker was ratcheting up interest rates, sending bond yields spiralling higher. Soon after he graduated in 1980 the 10-year Treasury yield hit a record of nearly 16 per cent — and the concept of sub-zero yields seemed preposterous.

“At school my textbooks said that there was no such thing as negative interest rates,” says Mr Ailman, now chief investment officer at Calstrs, the $238bn Californian teachers’ pension plan. “But here we are.”

In the wake of the financial crisis, many central banks deployed unconventional new tools to reinvigorate the global economy once interest rates hit zero. At first this primarily meant massive, multitrillion dollar bond-buying programmes, but in 2009 Sweden became the first central bank to experiment with negative interest rates.

It was later followed by Japan and the rest of Europe, with the desperate scramble for bonds pushing yields lower. Growing concerns over the health of the global economy, a subdued inflation outlook and expectations of even easier monetary policy have now pushed the pile of negative-yielding debt to about $13tn.

Pension plans invest in a broad array of asset classes, but with many stock markets at or near record highs, the prospect of gains are dimming across the board. AQR Capital Management estimates that the classic 60-40 balanced equity-bond fund might return as little as 2.9 per cent on average a year after inflation over the next decade, compared with an average of 5 per cent since 1900.

https://www.ft.com/content/c95deea4-03e2-11ea-9afa-d9e2401fa7ca