As you can see from this slide, the growth in pension costs has been tremendous.

Transcription

1 Remarks by Larry Fink National Association of Pension Funds Investment Conference Edinburgh International Conference Centre Edinburgh, Scotland March 5, 2014 (as prepared for delivery) I want to thank you for the distinct honor of joining you here today recognizing the extraordinary service you provide organizations and scheme members and working people in particular in these challenging times. I note that I am in extremely distinguished company: I have been preceded in addressing the NAPF by none other than the Prince of Wales. It was hard to miss his strong words to you to "make that innovative and imaginary leap that the world so badly needs, otherwise your grandchildren, and mine for that matter, will be consigned to an exceptionally miserable future." My own outlook is perhaps somewhat less grim. I m an optimist by nature. But there s no doubt you have a tremendous challenge before you in protecting and growing the wealth of millions of Britons in fulfilling our pension promises a challenge that is only becoming more and more difficult with each year. In addressing that challenge, I couldn t agree more with the bottom line of the Prince s remarks: all of us need to invest, operate our businesses and make decisions for the longterm. In that regard, the challenge facing not just pension plans but society as a whole in many ways the defining challenge of our time is the impact of longevity on our lives and our savings. Life expectancies at birth in the UK have now hit 82.7 years for women and 79 years for men, up roughly 8 and 10 years, respectively, since 1970 (Office of National Statistics) As you can see from this slide, the growth in pension costs has been tremendous. In 1971, each pound of retirement income cost about six pounds of savings for a 70 year old male. Today, that figure has ballooned to nearly 12 pounds.

2 Roughly half of that growth is due to changes in interest rates but the other half is due to longer lives. And the burden isn t going to lessen. As you see from this next slide, if life expectancy increases according to estimates, at current rates the cost would jump from 12 pounds to nearly 14 pounds. An additional increase of three years in life expectancy would bring that figure up to 15 pounds. On top of all this, there is also the concern that many pension plans aren t ready to meet 2

3 their liabilities to these Britons, a challenge that will only become greater as lives get longer. Overall, around 4100 plans were in deficit as of January 14, with a shortfall of over 139 billion pounds (Source: PPF). Additionally, the shift from defined benefit to defined contribution retirement savings has presented a huge challenge to individual savers here as elsewhere in the world. The government said last year that the number of people overall in an occupational pension scheme has plunged to 8.2 million, or 35 per cent, compared to 12.2 million in Plus, just 35% of men and 32% of women are topping off their workplace pensions with private plans. And according to BlackRock s Investor Pulse Survey, less than half of Britons have started to save for retirement. All of this is to say: you have your work cut out for you dealing not only with rising longevity, but greater regulatory compliance costs and meager returns on investment driven by declining gilt yields: The good news is that here in the UK, you have been willing to address the problem of longevity and its long-term effects head-on. Your work as pension professionals, along with many of the steps taken by the government, deserve applause. It took real courage to raise the retirement age to 68 and then to 69, one of the highest eligibility thresholds in the world. And the NEST plan and auto-enrollment initiatives are having a marked effect on the retirement landscape in the UK. The first full year of auto-enrollment has seen almost two million people saving for a pension who were not at the start of the year, particularly young people. (Source: DWP) By 2018 that number will rise to 11 million as workers will be signed up by default to company schemes. But even these important steps are not enough. We need people to save more, and save earlier. A big part of that effort will be educating people about the effects of longevity and the need to be ready for longer lifespans getting investors to grasp that the retirement behaviors of fifty years ago won t cut it today. As I have advocated in the U.S., I would recommend simply making an appropriate level of retirement savings mandatory here in the UK, without the opportunity to opt-out. This has been done with the superannuation system in Australia and has proven to be extremely effective. 3

4 Because even with positive steps like NEST and auto-enrollment, there is too much risk that people will either opt out, or not put enough away even if they remain in a plan. But the question isn t just about people saving more. It s what you as pension professionals do with these savings. The question that consumes you is how to make sure that when people are putting their money in your hands, you make it grow and help give them a secure retirement. There is no bigger responsibility and challenge than meeting the expectations of investors. And your responsibility isn t just to the young people who have many years to save, it s also to people who are nearing retirement or already receiving their pension distributions. The reality is that too many pension funds have not been achieving the returns they need to meet their liabilities. Some of this is a natural consequence of the financial crisis. But again, we need to accept the responsibility to rethink our investing approaches which brings us to the core question of how to meet our pension promises. This challenge will require a rethinking by institutions of investment approaches and the market to get beyond the reluctance to adapt to changing market forces such as the end of the bull market for bonds and the increasing correlation across asset classes and to seek the returns that retirees need was a remarkable year for markets 2014 isn t going to look the same. We are going to see choppy markets, likely some continued volatility in EM, and a continued increase in rates partially due to the ongoing taper of quantitative easing in the U.S. You are going to have to find ways to grow in a more challenging environment. As central banks pull back their stimulus programs, the role of fiscal policy in shaping economies will only grow. And as we know governments are unpredictable, which will add another layer of complexity to predicting growth and markets, and increase the risk of volatility. And again, longer lives and increasing pension liabilities are going to have an effect on both the shape of the workforce and government budgets. That s not the only obstacle to growth. I spend a great deal of time on the road, meeting with companies around the world, and something that I continue to see is the massive effect of technology on jobs. 4

5 One of the most striking examples I remember is from one of the largest construction companies in India. The CEO told me that in the same factory, they went from 10,000 employees to just 1200 with a 30% increase in productivity. This is something we are going to be confronting for years and it s true for all nations, not just developing ones. We remain in an uncertain time, still sorting out the meaning of the crisis. Tepid economic growth against the backdrop of rallying markets, ongoing volatility, and a looming, perhaps long-term rise in interest rates, All of it adds up to a very challenging and sometimes confusing investment environment. If I was a pension plan CIO I would be asking myself some important questions at this time: Above all, I d be asking: Have I adequately considered the impact of longevity on my liabilities? Last week I was visiting with the chairman of the one of the largest pension funds in the U.S. He told me that they had just finished a review of their liabilities and concluded the duration was too short given the realities of longevity. So they re now going to be taking a big hit and extending their liabilities and in turn, they re reviewing their assets to see what they ll need to do to meet those liabilities. If don t get your liabilities right including the way you factor in longevity then the management of your assets can t possibly be right. On the asset side, you need to make sure you are asking how will the assets perform, relative to liabilities, under different market scenarios? Do I believe I am getting adequately rewarded for the risks I m taking? I know that many are considering buy-out deals (what we call defeasance in the U.S.). The pros and cons are unique for every plan and need to be carefully weighed. In terms of fixed income, is the portfolio sufficiently taking into account the future interest rate movements? In equities: do I need to reassess the risks in the portfolio, and the areas of exposure, given volatility and the market rally in 2013? What alternative assets and investments can I access to diversify risks and sources of return? 5

6 Many of you are facing the difficult question of to hedge or not to hedge, particularly if you are not yet fully funded. I do believe that pension managers will need to take a bold approach in order to meet liabilities a greater willingness to explore alternatives, including hedge funds, and to explore more flexible, non-traditional bond funds. With interest rates anchored near historic lows, cashflows beginning to turn negative in some plans, and uncertainty over quantitative easing, there are undoubtedly some decisions to be made over fixed income allocations. The risks of sharp moves in interest rates are high. Having a flexible and active allocation here seems sensible, as does considering alternative sources of income from things like real estate, alternative credit, natural resource financing, renewable power and infrastructure. We are big believers in dynamic multi-asset strategies which have flexibility in these challenging times and aren t tied to any given benchmark or beta exposure. These funds have also proven their worth in minimising losses in stressed markets. Alternative allocations are becoming an increasingly important component of pension funds. In the five years since the financial crisis, institutional investors alternatives allocations in the UK have grown by 60% and with good reason there are some great investment opportunities. If your liabilities are long-dated into the future, you can benefit from the illiquidity of private equity and real estate markets to earn a premium, for example, and a source of income. Quality alternative investments can provide attractive returns relative to equities and often for the same or less risk, while also diversifying the portfolio. If you need growth, continue to explore hedge fund opportunities. If you need uncorrelated returns and genuine sources of alpha there are real opportunities here. Our research of the hedge fund industry last year showed the top quartile managers delivered over 10% of alpha. But this isn t just an asset allocation issue picking the right manager is key, as the dispersion of returns in these areas is much larger than in traditional mutual funds. Finally, you should continue to refine your mix of active and indexed funds, finding which areas are best served by each approach. For basic asset class exposure and shortterm trading, index funds remain the way to go. And when you have confidence in a particular strategy or manager, go active. There s no one solution, of course, and each fund has different needs. 6

7 And navigating the challenges of this period what you might call post-post-crisis is a remarkably difficult task. We are living in a world not just reshaped by the crisis, but also facing tremendous structural challenges including increased longevity and the effects of technology on jobs. That is why I urge closer collaboration across the industry. Pension schemes, consultants, asset managers and policy makers have the opportunity to work together to solve these problems. We need to continue to develop policies that help people save for retirement, and as an industry, we have to work more closely with the people we serve to offer products and services that help them save for retirement, and to communicate more effectively about the ways to save and the urgency of doing so. This is no easy task. But I have no doubt we are up to the job and can avoid the exceptionally miserable future the Prince warned of. Thank you for having me here today. 7