Dick Rae, Chair of the IFoA’s Finance and Investment Board considers the history of long-term investment ahead of the Autumn Lecture, delivered by Lord Myners next week.
Oh to be in Edinburgh for this month’s Autumn Lecture where we have Lord Myners addressing the subject of long-term investment. For those of us in pensions and life insurance, this has a special resonance. I have to conceal a wry smile as politicians embrace the “new found” potential of life insurance companies and pension funds as natural long-term investors.
Always was it thus! This potential for long-term investing was recognised way back when premiums paid into life assurance savings plans could qualify for tax relief to encourage long-term saving. In those days the ability of the general public to invest in stocks and shares was limited and insurance companies became a conduit for them to access equity markets. As a result, insurance companies became powerful providers of long-term equity finance to British industry. This was later followed by pension funds as they collectively grew into an enormous investment fund industry.
Now as new investment money struggles to find decent returns, pension funds and annuity writers recognise the strength of their long-dated cash flow liabilities in allowing them to give up investment liquidity in return for extra yield. They are ideal funders of long-dated infrastructure projects. So attractive is this potential that the European Commission was keen to encourage long-dated infrastructure investment through a lower capital charge under Solvency II. It took two attempts, but EIOPA was finally able to provide the evidence the politicians were asking for.
The head winds though are against the life insurance and pension funds as being a sustainable source of long-term funding. In different ways the burden of regulation has killed off both the with-profits industry and defined benefit schemes. Equities need to be held in the long-term for any equity risk premium to be earned with any degree of confidence. This means being exposed to short-term volatility though. This comes with high capital charges for with-profits funds and for many funds the cost of writing long-term guarantees is too great.
For pension schemes the story is different although the outcome similar. The effect of many years of regulation aimed at making DB scheme benefits fairer has been to transform what was an ambition to provide income in retirement into something much closer to a guarantee. The emergence of financial economics and years of falling interest rates has killed off this type of scheme in the public sector. These schemes are no longer the provider of long-term equity funding that they were although, whilst they wind down, they have been an invaluable long-term investor in fixed income assets.
Now new pension and investment schemes pass investment risk back to the investors in the form of non-profit unit-linked investment plans and defined contribution pension schemes. Here the emphasis is on short term performance and liquidity. No longer is there a certainty that any fund manager will retain its funds under management. It’s almost ironic that the political will to abolish compulsory annuitisation has enhanced the flow of cash into more liquid investments. As a consequence, the ability for these industries to retain long-term investment horizons looks at best challenged and, in the long term, unsustainable at least in terms of any form of illiquid investment offering better returns.
Of course, Lord Myners is likely to take an entirely different angle on long-term investment. He may be asking much more cerebral questions around economic cycles and even whether there is such a thing. To find out you’ll have to make your way to the Autumn Lecture either live in Edinburgh, via livelink in London and Johannesburg or you can sign up for the online livestream from anywhere in the world. If you do watch the lecture, be sure to post your comments. Did you know that there is now a Finance & Investment LinkedIn group where you can do this? Visit LinkedIn to join the Group.