Asset AllocationSeptember 24, 2013

Longevity Increases Are Leading to ALM Shift

<em>Lengthening life expectancy assumptions are changing the way investors think about asset liability management.</em>

Reported by Featured Author

(September 24, 2013) — Gains in longevity are forcing pension funds to consider increasing their exposures to equities, according to research from Axa Investment Management (Axa IM).

The latest longevity assumptions have shown that half of all children born today in highly developed countries could well live for more than 100 years.

That means that for every new day we live, we gain an additional five and a half hours of life expectancy at the end of our lives.

The rapid life expectancy rise, combined with baby boomers approaching retirement and a low-yield environment has forced a rethink when it comes to asset liability management (ALM) strategy, Axa IM said.

“In order to pay additional annuities in the short term, pension funds need to invest in higher return assets such as equities or real estate,” the report said.

“With increased pressure on the short term horizon of their liability and a chase for yield that delivers in the longer term, pension schemes are caught in a duration mismatch which keeps widening as the new demographic, post baby-boom, is getting closer.”

Tilting the balance towards equities would hopefully compensate for depressed bond yields, a tactic which the report said was already being employed by some major fund managers, which were shifting their retail communications targeting new retirees and workers about to retire.

“At the level of institutional investors, this unconventional approach is being adopted as well. It is striking to note that CalPERS, a major US pension fund whose client base is vastly exposed to population ageing, has not tilted its exposure to bonds as might have been expected,” the report continued.

“The change in its clients’ life expectancy outlook and the age pyramid implies that the liability profile is extending. CalPERS data show that the overall allocation has experienced a slight decrease in fixed income exposure, while exposure to traditional equities has lost some ground, but mainly to the benefit of private equity and other alternative investments rather than to bonds.”

The rise in life expectancy has also seen a shift away from domestic bias, most notably in Japan, where longevity assumptions are at their highest.

In Japan, the hunt for yields has taken the form of international diversification in order to benefit from higher overseas returns.

The recent decision by the Japanese public pension fund (GPIF)–which manages around US$ 1.1 trillion of assets–to diversify its allocation toward overseas securities evidence of this, the report said.

“The Japanese experience shows that, in the context of depressed real yields (in local currency), the home bias of pension funds is likely to be re-assessed and to generate a search for higher return overseas.”

The full report can be read here.