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The return of something to lose for pension asset allocators

James Fouracre
Director – UK Institutional

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.

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The views expressed in this article are not intended as an offer or solicitation for the purchase or sale of any investment or financial instrument, including interests in any of Ruffer’s funds. The information contained in the article is fact based and does not constitute investment research, investment advice or a personal recommendation, and should not be used as the basis for any investment decision. References to specific securities are included for the purposes of illustration only and should not be construed as a recommendation to buy or sell these securities. This document does not take account of any potential investor’s investment objectives, particular needs or financial situation. This document reflects Ruffer’s opinions at the date of publication only, the opinions are subject to change without notice and Ruffer shall bear no responsibility for the opinions offered. Read the full disclaimer.

London
80 Victoria Street
London SW1E 5JL
Edinburgh
31 Charlotte Square
Edinburgh EH2 4ET
Paris
103 boulevard Haussmann
75008 Paris, France