Of all the forces set to reshape the investment landscape over the coming decades, one stands above all others – the ageing of the world population.
In Europe, for example, life expectancy has risen by eight years since 1970. By 2050, 22 per cent of humanity – or some 2bn people – will be over 60 years old.
There is a common view on how this demographic shift will affect investment. The general assumption is that older people are more risk-averse and more focused on drawing income.
Extending this logic, an ageing world should mean greater demand for bonds, less appetite for equities and a higher equity risk premium.
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Long retirement means risk on
We disagree. As people live longer, they will spend more time in retirement and thus need larger pension pots.
So even if the pensioners of the future conform to today’s risk-averse stereotype, they will first need to grow their investments more quickly to make their retirement possible.
Returns, rather than the mitigation of volatility, could become the main investment target. And this means a greater proportion of investors will need to take on more risk – and possibly do so for longer.
According to our calculations, the current average UK pension fund mix (47 per cent equities, 36 per cent bonds, 17 per cent alternatives/other in 2017 according to Willis Towers Watson) will return 0.5 per cent a year less than would be required to reach a 50 per cent coverage of final salary at retirement.
A more growth-focused portfolio should serve investor interests better by replacing some of the traditional bond holdings with a greater allocation to equities and alternatives.
A 50/30/20 split would, for example, achieve the target, as long as a higher-risk, higher-return alternative, such as private equity, is selected.
Range of assets available
What else could become a more prominent feature of these new portfolios?
For one thing, infrastructure investments should become more popular as cities adapt to cater to the ageing population. Private asset classes should also rise in popularity, with more vehicles designed to give mainstream investors access.
Increased demand for riskier assets, in turn, is likely to result in the development of new investment products.
These could take the form of higher-risk, growth-focused wrappers for defined contribution savers, new outcome-oriented fixed income strategies, as well as products that lock capital away for relatively long periods of time.
In the face of growing demand, we also think the rules on pensions will be relaxed to allow investment in a wider range of assets, including illiquid ones.
Retail investors join the party
At the same time, we expect that retail and wholesale investors will also gain access to a wider range of products, including ones which are currently reserved for institutions.
In a decade or two, personal pension savings could well feature private equity and maybe even cryptocurrencies alongside government bonds.
There is also likely to be increased appetite for advice to better navigate the new investment landscape, particularly among the growing number of DC savers. More of that advice will come from robots of various forms.
The longevity-driven shift in portfolio allocation is likely to crystallise as the first wave of DC pensioners approach retirement over the next two decades. US workers, for example, have an estimated retirement deficit of some $4.13tn more than a fifth of the country’s GDP.
To adapt our portfolios for longer lives and longer retirements, we will need to take on more – not less – risk.
Date: September 7, 2018
Source: Pensions Expert