Pension Funds Letter 9 - The Covid-19 crisis: two sides of the same coin for pension funds

From a long-term investment perspective, the unprecedented global crisis caused by the Covid-19 pandemic brings along both challenges and opportunities, which constitute two sides of the same coin for institutional investors such as pension funds.

Beyond the unavoidable market turmoil, the Covid-19 crisis will impact the future macroeconomic and societal state of the world, with tremendous implications for asset owners. From an economic point of view, they will need to adapt to a new era, characterised by the comeback of Central Banks’ Quantitative Easing programmes, the increase of inflation volatility, if not inflation itself, and the threat of “deglobalisation”. From a societal perspective, institutional investors will have to cope with the numerous uncertainties surrounding the low-carbon transition and the struggle against global inequalities.

To face all these challenges, pension funds and other institutions should equip themselves with the right investment tools. In particular, they should increase their allocation to bonds eligible for Central Banks’ purchase programmes and boost their share of inflation-hedged securities. Last but not least, whatever the realised scenario for the low-carbon transition and for inequalities, institutional investors ought to intensify their commitments towards responsible investment by integrating climate and social risks into their investment frameworks and allocating more assets towards ESG funds, which have proven to be very resilient during the pandemic.

However, the coin of the Covid-19 crisis has another side, which pension funds could exploit to seize investment opportunities, in both the short and long-term. From a conjunctural standpoint, they may take advantage of credit risk premia embedded in the significant credit spread widening that has materialised during the crisis. By doing so, they would be able to hedge, at least partially, the negative outcome of the market turmoil on both sides of their balance sheet, especially if they abide by the IFRS or US GAAP frameworks. From a more structural perspective, the Covid-19 crisis also constitutes a source of opportunities for institutional investors with a long-term investment horizon. As far as asset classes are concerned, they may find interest in investing in European real estate securities in order to capitalise on their defensive features, including their ability to dampen volatility and bring portfolio diversification. When it comes to portfolio construction, pension funds might also harness the pandemic to fundamentally revisit their investment framework, moving from a traditional Strategic Asset Allocation model (SAA) towards a more agile Total Portfolio Approach (TPA). While this switch requires new skills and a profound change in governance, it will enable asset owners to better apprehend the complex environment driven by the Covid-19 situation.

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