After Antonio Stradivari died at 93 in 1737, generations of instrument makers had been searching for the secret responsible for the inimitable sound of the Stradivarius violin. And late last year, the secret was demystified. The conclusion of a study, involving seven leading German and French laboratories over four years, resounded beyond close circles of musicians: "He might not have possessed an unusual or 'secret' ingredient, but he was an outstandingly skilled craftsman who had mastered the art of violin making."
Assembling components for a violin resembles in a way the process of selecting and allocating assets for pension planning.
Switzerland is a good example of how pension fund management firms work to match their assets with their liabilities. With an ageing population, managing risks and investment performance according to various time horizons have become key to their operations. And firms recognise that attracting talents also depends on their pension funds' ability to deliver. As a result, benchmarking investment results has become a standard within the industry.
The process of comparing results with benchmarks enables investment committees to identify sources of under- and over-performance. Moreover, undertaking such an analysis on an ongoing basis may lead to better investment decisions in the long run. As a result, institutional investors sometimes turn to benchmark providers such as Pictet to assist them in their asset management. In our case, a long dated experience in the field of asset management, and pension benchmarks in particular, attracts interest from institutional investors across the Swiss borders such as the Netherlands and Great Britain, markets which are renowned for their pension planning.
Rapidly changing demographics pose a mounting challenge to the way the Gulf Co-operation Council (GCC) states currently manage their pension funds in order to meet their future liabilities.
Pension funds in the GCC countries are also recognising that professional asset and liability management will play a significant role in the future. A study conducted by Booz & Company shows that in the next 25 to 40 years, GCC's pension funds will be unable to meet their obligations unless they proceed with major changes in their current structures. Today, GCC's pension funds benefit from a very young population. For every one person who pulls money out of pension funds in the region, there are 25 working people contributing. As a result, a number of pension funds in the region manage their operations on a very short term basis, virtually like money-in and money-out current accounts.
But after the next decade, during which the average population growth rate will average about 1.9 per cent per year, it will decline to 1.5 per cent for the 2015-2025 period. By 2050, there will remain only three workers for every retiree. Consequently, pension funds will increasingly become insolvent if changes are not implemented. Thus, pension funds in the GCC are today at crossroads and need to adapt to much longer term time horizons, if they intend to achieve the growth needed to meet their future liabilities.
And in the current low interest rate environment, finding and assembling assets that will match future pension funds' liabilities requires teams of qualified professionals.
Such teams could help establish tailor-made pension indices in the GCC, with asset allocations reflecting various investment objectives of risk tolerance and expected rates of return, given estimated future liabilities. Written investment policies could be produced, setting the guidelines for allocating funds to various assets ranging from high rated traditional funds to alternative investments such as hedge funds and private equity. Consideration of local investments requirements can also be integrated in the overall asset allocation.
Just as in Europe today, if GCC pension structures are to offer not only solvent plans, but also attract and retain talents, the aspect of providing employees with a competitive advantage in their retirement prospects will become more and more significant over the coming years.
To meet their beneficiaries' long-term needs, pension funds' trustees should adopt a number of best practices in the daily management of their assets. Clients should implement the following five, which appear as the most significant:
- Goal: clearly define the beneficiaries and their benefits.
- Ethics: be fair to all beneficiaries, foster loyalty and avoid conflicts of interest.
- Organisation: define roles and responsibilities, align skills and consider checks and balances.
- Process: establish procedures, relevant reporting and transparent communication.
- Investments: follow the "prudent investor rule".
- The author is with Custody Services of Pictet & Cie, Dubai. The views expressed are his own