Asset management industry could help to solve retirement income issues

In the long run, we are all dead. This much is familiar to most investment professionals, but John Maynard Keynes’ oft-quoted dictum continues like this: “Economists set themselves too easy, too useless a task if in tempestuous seasons they can only tell us that when the storm is long past the ocean is flat again.”

So in essence, it appears to call for a more short-term focus in risk management.

Since the financial crisis, risk management has come to the fore for investment managers globally, but the focus is short term.

With volatility the main proxy for risk, it is hard to think about risk in periods much longer than a year. However, volatility rarely corresponds to the most relevant risk for the vast majority of investors.

Retirement income

This is, of course, the risk of failing to accumulate enough money to meet their aims, usually a reasonable retirement income.

Some retirement savings systems still work on the defined-benefit framework, where the outcome is given some level of guarantee and the risk of meeting or not meeting it is held either by a company (as in the US and UK) or a collective of pension scheme members, such as in the Netherlands.

But globally the trend is towards deconstructing that aggregated risk and putting the burden largely or entirely on individual savers, who are not necessarily well equipped to understand the investment decisions they are making.

The recent UK decision to remove the obligation to use one’s pension savings to buy an annuity could be seen as a response to the risk of low interest rates at retirement (buying an annuity in a low interest rate environment guarantees a permanently low income), but it replaces the risk of a low income with the risk of no income at all if the money runs out before the pensioner dies.

In the Australian system, all workers are required to save into what are known as super funds (that is short for superannuation, rather than a comment on quality), and there is no compulsion to annuitise on retirement.

This has been held up internationally as a model system, and it has certainly stimulated the Australian asset management industry.

However, as it matures, questions around its adequacy are growing, as critics point out that savers are not putting enough in to guarantee a sufficient retirement income.

This problem is common to pension systems everywhere, particularly as demographics change, increasing life expectancy and lowering birth rates until the number of workers supporting retired people decreases to unsustainable levels.

There is a structural obstacle to dealing with all of this. The problem is a very long-term one, but the pain of solving it is likely to be taken in the short term.

Since democratic governments have limited terms, after which they must appeal to the electorate, they are never strongly motivated to take short-term pain for long-term gain.

Savers themselves should be better motivated, but the behavioural problem known as hyperbolic discounting means we will always struggle to value a good far distant from us in time above and beyond that of even a much smaller good today.

Clout and expertise

This leaves the asset management industry as possibly the only body with the clout, the expertise and no serious disincentive to developing an effective retirement savings framework.

There is no obvious reason why such a framework could not be as profitable as more flawed systems. The expertise is there if anywhere and there is even a sufficient number of highly motivated people who genuinely want to use their time and talent working out how to protect retirement incomes.

In the long run, we will assuredly all be dead, but the salient question is whether we are protected against having to go through years of poverty to get there.

The asset management industry needs to take this opportunity for leadership to provide that protection.

– (Copyright The Financial Times Limited 2014)