The return of something to lose for pension asset allocators

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Articles by James

James Fouracre

Director – UK Institutional

30 August 2022

A ripple of excitement washes over the crowd. A towering, fluorescent clad figure gallops up the pitch, across the halfway line, and onwards still, to join the melee in the opposition’s penalty box.

It’s the cup final, they’re a goal down and the clock has ticked into the third minute of stoppage time. This is the final throw of the dice, there is nothing to lose.

With nothing to be gained from the risk-free option – staying put between her own goalposts – the risk calculus for the goalkeeper has changed and with it, her behaviour.

Pension scheme asset allocators, after decades of freefalling interest rates, might just be able to relate.

This chart shows the results of an experiment to see how investors change their portfolio allocation between a risky and a risk-free asset in response to changes in risk-free rates.

At a 5% risk-free rate, they allocate around 57% to risky assets.

At a 0% risk-free rate, they allocate around 70% to risky assets.

The change in allocation is material and convex. When interest rates fall below 2%, risk taking behaviour seems to increase non-linearly. Put another way, when there is nothing (or very little) to be gained from choosing the risk-free option, investors throw caution to the wind – leaping into riskier assets, not merely edging towards them.

Just like our goalkeeper.

But let’s change the conditions, and say the scores are level and extra-time is on the line. The risk-free option - staying put between the goalposts - now has some value. How does the goalie’s behaviour change when there is something to lose?

As interest rates rise, the risk-free option becomes more appealing to pension scheme asset allocators. And we should expect their behaviour to change. The reversal of allocations to risky assets as risk-free rates climb is likely to be just as material, and just as convex. Flows out of risky credit and equity markets could ramp quickly as pension investors, once again, have something to lose.

The speed at which markets can move in moments like these favours the well-prepared. It’s why we’ve bolstered our derivatives-based protection strategies, reduced exposure to equities and remain resolute to our objective of protecting clients’ capital – whatever happens in financial markets.

Articles by James

James Fouracre

Director – UK Institutional

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Piers Wheeler

Director – Global Institutional

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Developing and executing asset management strategy for capital raising and strategic relationship management. Coverage includes EMEA, Asia and Australia. Piers joined Ruffer in 2021, having previously worked with asset management firms including Eastspring, AMP Capital and LEK as a strategic consultant. He holds a MA from the Bayes Business School and a BA (Hons) from the University of Oxford.

Annabel Paterson

Senior Associate – Global Institutional

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Joined Ruffer in 2021, having graduated with a first class honours degree in land economics from the University of Cambridge. After two years working with the UK Private Wealth team and completing her IMC and CFA Level I qualifications, she now supports Ruffer’s global business development and client servicing efforts.

Articles by Annabel

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The return of something to lose for pension asset allocators