Pension Funds Letter 10 - Resilience is all

Summary

EDITORIAL

Resilience is all

Today, investors have a unique opportunity to observe the spreading of a real virus alongside the viral nature of financial markets and the real economy. As Nobel Prize-winning economist Robert Shiller points out in his book, “Narrative Economics: How Stories Go Viral and Drive Major Economic Events”, stories and images are created around new economic events¹. In some cases, these stories are memories of the past and their spreading can have major implications regarding performances of economies and financial markets.

Two conflicting narratives are now playing in the markets: one positive (election of Joe Biden, news of a vaccine becoming available soon) and one negative (pandemic second wave and its negative economic consequences). In that context, pension funds may follow interest rates movements: they will lead the narrative path and drive investors towards possible changes.

As the situation becomes clearer over time, pension funds will be dealing with how to build resilient portfolios. But what does resilience mean in the context of a deep recession which turned investment returns into a monetary phenomenon? The Amundi-Create 2020 survey provides some answers. It means targeting backstops or inbuilt shock absorbers or both. It implies selecting firms that can weather the storm and emerge stronger. Scenario planning and liquidity management are the necessary tools to navigate resilient asset allocation. Pension funds goals in that area will reinforce the alpha–beta separation, as fees become a key source of returns. Indeed, equities will retain their gravitational pull while passive funds will continue their ascent by tilting towards megatrends.

Analysis is also changing. Pension funds may now look to the future rather than the past. The “factoring future into the present” process has enabled ESG funds to shine in the pandemic context. Their resilience owes more to stock selection than sector bets. They have reminded pension investors that the success of ESG rests on a ‘just transition’ to a low-carbon future, unlike globalisation.

The implied green evangelism underscores another core message: the old shareholder primacy model can no longer be relied upon to create sustainable economies that will deliver affordable pensions to millions in an interconnected world where negative fat tailed events are no longer a rarity.

This shift in mindset marks a defining moment.

_{1. In the words of Shiller, narrative economics is: “a theory of economic change that introduces an important new element to usual list of economic factors driving the economy: contagious popular stories that spread through word of mouth, the news media, and social media”.}

EXECUTIVE SUMMARY