Brexit holds profound implications for European pension funds, said Matti Leppälä, secretary-general and chief executive, PensionsEurope speaking at the Fiduciary Investors Symposium in Cambridge. One consequence is a shake-up in the asset management industry they rely on if a No Deal leads to UK service providers losing their passporting rights, the complex system that currently allows them to offer services across the EU. It depends on equivalence, but Leppälä noted that EU will look after member states over UK service providers and that “equivalence can be withdrawn at any moment.” Similarly, pension funds rely on London-based clearing services for their derivative exposure and access to hedging strategies. “This is continuing for the time being” he said, with a note of caution.
He said that UK pension funds are relieved at the prospect of being outside EU solvency regulations. These strict rules on capital requirements would have demanded huge amounts of capital flow into pension funds to improve their funded status. “In this respect they favour being outside the EU,” he said. However, this is balanced by negatives, like the impact on UK funds’ UK assets if the economy takes a dive. This is a worry compounded by the slow growth and contribution level into the UK’s DC pension schemes, raising the prospect of poor pension provision for future generations.
Of course, Brexit offers opportunities for investors too. Volatility is good for alpha and active strategies, said Nick Stanton, head of multi-asset strategy at the State of Wisconsin Investment Board. However, he noted that investment opportunity is difficult to see in the current turmoil; opportunities are more likely to appear in the aftermath, like a hard Brexit leading to the pension fund buying the pound or picking up undervalued UK equities.
SWIB has also found a rich seam by stepping in to provide liquidity in times of crisis, something investment banks rarely do anymore. Stanton said that this strategy requires acting quickly, which is best done by delegating decision making to investment staff. “This is where pension funds should concentrate now. They need to get the resources in place to act quickly,” he said. Getting in position to strike could include positioning to sell volatility when volatility spikes and looking to hire global macro managers. The pension fund’s asset allocation is set by the board, but the investment team are allowed a generous tracking error, he said. If they require more flexibility here to take advantage of a “large event” it requires board permission. He also noted that Brexit is taking a toll on UK company values as they stall on investment decisions. There is a lot of commentary about UK companies pulling back; this isn’t good for long term returns, he said.
Fixed income investors hunting for yield in the low rate environment and Brexit uncertainty are exploring a number of strategies, said Pilar Gomez-Bravo, director of fixed income, Europe, MFS Investment Management. Noting that Brexit is “a process” she said investors have time to manage and hedge their exposure in the event of a No Deal. “It’s great to seek alpha, but you also need to protect the downside,” she said. She suggested investors start to think about tail risk hedging through credit options because volatility is still low. “Avoid being stuck with no liquidity; if volatility is subdued, think about tail risk hedges.” The damage to the UK economy in the event of a harsh Brexit will have implications for Gilts, but other strategies also hold challenges.
Many pension funds are investing further out on the credit quality spectrum, switching to exposures in emerging market sovereign debt. The challenge here is that these strategies have a high correlation to equity, she said. Private debt is another popular strategy for its illiquidity premium. “We will have to wait to see what these portfolios do,” she said.