The Weekly Update

The pension industry wasn’t particularly well established in the 14th century (during the time of the Black Death) as such they’ve not really ever had first-hand experience with shrinking national populations and their painful effects on growth expectations and pension liabilities. The next 50 years will see a prolonged stalling of population growth and labour force shrinkage across almost all developed and many emerging countries to an extent not seen for over 650 years. Global population should continue to rise (to rough estimates of 9.7bn by 2050 and 11.2bn by 2100). But over half of this growth will be from Africa meaning that its population of 1bn now could triple by 2100. Meanwhile the number of countries with shrinking populations is expected to reach 100 including almost all developed countries. Currently around 25 countries have notable long term declining population trends but importantly this includes the likes of the US and Japan and would include Germany but for the wave of migration in the last decade. Such migration is clearly becoming less popular within wealthy nations; the forthcoming boom in African population could thus have significantly less impact in places such as the US and EU compared to the economic boosts we have seen from past Eastern European and Asian migration. For example over 80% of immigration into the US over the past three decades has been working age (16-64).

In contrast to all the warning signs, large parts of the pension industry continue to extrapolate the boom years of the 80s and 90s into their current and future expected returns (discount rates) hoping for as much as 6-8% in perpetuity. They seem to be brazenly ignoring recent trends and the ebbing growth catalysts of expanding debt and demographics, both clearly unsustainable and nearing breaking point. As they continue to maintain such optimism they are simultaneously being forced more into negative yielding government paper and/or risky assets.

The concept underpinning the Stratton Street Next Generation Global Bond Fund questions the logic of lending to increasingly indebted governments as yields decline, particularly as yields turn negative. The whole point of investing is to achieve good risk adjusted returns. Paying a government to take your money to guarantee you receive less capital in x years time, turns that idea on its head.  An illustrative and infamous example is the California Public Employees' Retirement System; CalPERS is the largest public pension fund in the US, managing around $300bn in pensions for over 1.6 million people. Even with maintaining its fanciful discount rate (expected performance) of 7.5% it remains 30% underfunded. This optimism is compared to flat performance for 2014-15 and an $8bn loss last year to end June. Such discrepancies are widespread across public and private defined benefit pension funds. But the risk isn’t annulled with the trend towards defined contributions. For if growth remains subdued then such plans will certainly fail to meet the needs - obliging a safety net from old age penury in the form of further state welfare spending on the elderly.

Indebtedness comes in various forms; for countries we see it vital to assess current public, corporate and household debts using our Net Foreign Asset analysis. In recent years we’ve seen how foreign currency liabilities can balloon or transfer between private and public balance sheets. Yet future pension liabilities are exponentially more vulnerable and subtly poisonous as Warren Buffet famously and engagingly outlined in a letter from 1975 on their obfuscated risks. There are risks to the expected returns from slowing growth and aging demographics, to final salaries in countries where governments may seek to boost wages such as Japan’s promoted fourth arrow, and increasingly to life expectancy. Harvard Business Review cites demographer Professor James Vaupel’s estimation that 50% of babies born since 2007 in the US, UK, Germany, France, Italy, Canada and Japan should have a life expectancy of 104 or more. Moreover just look at the recent leaps in biotech such as the potentially life prolonging use of CRISPER/Cas9 on the telomeres in DNA (worth looking up if you’ve not heard of it). There is reason to believe why life expectancies, which have come from mid-thirties in the 14th century to mid-seventies now, could continue to rise in the decades ahead.

In this imbalanced world it’s easy to see how accountants and investors still underplay the potential risks of indebtedness ballooning from even their current unattractive levels. This is why in a world full of expectations from a bygone debt and demographic fuelled boom of the 80s and 90s we are advocates of an investment philosophy that is prepared for deleveraging and avoids those heavily indebted. We prefer creditor nations and corporations operating in such nations that will not face such significant risks and drags from their liabilities whilst maintaining realistic yet attractive yields. The next generation will need to think very hard about what constitutes good risk and reward and we hope the Next Generation Global Bond Fund will provide a potential solution.