By Shane Brett, Managing Director, Global Perspectives
“Prichard is the future, we’re all on the same conveyor belt. Prichard is just a little further down the road.”
Michael Aguirre, New York Times, 22 December 2010
In 2009 the small Alabama city of Pritchard, outside Mobile became the first city in America to stop paying pensions to its retired workers.
For years the city had been warned that if it did not put more money aside its pension fund would run dry. It was even ordered to do so by the State court.
The City Mayor ignored the court order, deciding it would be better to keep hospitals open, street lights on and paying teachers’ salaries. The additional money to fund the city pension liabilities simply didn’t exist.
Many of the affected retirees have now filed for bankruptcy or gone back to work.
The Future of Pensions
This is the future across the developed world.
Private sector workers in rich countries already know the days of defined benefit pensions on retirement are long gone.
Employees in the private sector have realised that they are in charge of looking after their own retirement. Their existing employers will contribute something but are in no way responsible for providing a comfortable income on retirement nor will they backstop the performance of their private pension fund.
The big change over the next couple of decades will be in the public sector.
This will be the inability of rich world governments to fund their public sector employee pensions.
Governments across the rich world have already accrued gigantic unfunded pension liabilities, the majority of which are of the defined benefit kind (i.e. guaranteeing a pension based on final salary). In most cases these future liabilities are not even included in national debt figures.
The slow realization by both governments and their state employees that the money to fund their retirements does not exist, will be one of the defining themes of the next 30 years.
Rich governments are already finding it difficult to fund even existing public services under crushing national debt. There is no way they can feasibly fund additional future pension liabilities as populations decline, birth rates stagnate and life expectancy increases.
In the US public pension funds from Illinois to Philadelphia to San Diego are all under enormous strain. This will exacerbate over the coming years as more people retire and live longer, healthier lives.
However, at least the US has a replacement birth-rate. In Europe (outside of the UK, France & Ireland) birth-rates has plummeted over the last 4 decades. This has been particularly marked in Eastern and Mediterranean Europe where many countries are in significant population decline.
Populations in many European countries have not saved anything whatsoever for retirement, leaving it wholly in the hands of their governments to provide a satisfactory income for their twilight years. These same governments are now sinking under massive public debt.
The German economy may be healthy now, but its population is due to fall 15% by the middle of the century. Trying to maintain a high standard of living and pay generous pension benefits will be impossible. It is no wonder they save so hard.
Train drivers in France famously retire at 50. In Poland army and military officers retire after 15 years. 33 year old pensioners exist across the country.
Other countries are actually going backwards. In an attempt at maintaining his declining popularity Putin’s Russia has just completely scrapped employee contributions towards their pensions. This from a country that already has 87 pensioners for even 100 workers (and which is forecast to reach 100 pensioners to 100 workers by the end of decade).
Worse, some governments have already raided state and private pension funds to finance their existing economic difficulties (for example Argentina & Ireland) leaving their future national retirement funding particularly precarious.
The future global pension crisis will likely come with a bang and not a whimper. This is because large voting numbers of older workers make reform unpalatable and unpopular. Politicians seeking re-election will not suggest fundamental pension reform. Unions will not allow it.
Instead state pension coffers around the world will simply run dry. Court cases will be mounted by those affected and probably won by them too – but that won’t change a thing.
The money to pay the rich worlds enormous unfunded pension obligations does not exist.
What this means for asset management
Why is this so relevant to the asset management industry?
Public sector workers worldwide will slowly come to realise what private sector workers already know – are in charge of funding your retirement.
For those in asset management this will be a very positive development.
There will be a long term surge in demand for successful fund managers, those who can generate alpha and provide stable long term returns.
All this could mean an avalanche of new capital into the industry. Far more savings and investment will be directed towards asset management as the rich world’s public sector workers try and adequately fund their future retirement.
Individuals will have to contribute more of their income. Governments will be made to properly fund their future (smaller) pension liabilities – their existing funding shortfalls having been so comprehensively exposed in the years ahead.
The hunt for yield will increase the demand for a variety of assets and investment types. This will expand the reach of Alterative Investments (such as Hedge Funds) and increase their allocation by retail investors.
The long term nature of many pension investments may also mean opportunities for Private Equity managers. Those invested in long term company turnarounds or stable infrastructural projects (roads, bridges etc) may be an attractive multi-decade investment.
The future parallel commodities boom will also mean huge growth opportunities for resource focused managers. The 50% increase in world population by mid-century and the declining reserves of many minerals, metals and energy will result in a huge increase in demand for these commodities and their related investments (e.g. mining services, technology and exploration).
This could be particularly prevalent in agriculture and energy. The world’s attempts to feed a burgeoning population and provide cheap renewalable energy to its population, could dovetail nicely with an expansion of investment in those areas by global pension funds.
Stein’s Law tells us that “If something cannot go on forever, it will stop”.
This is what Pritchard, Alabama shows us.
The governments of the rich world do not have the financial assets to match their unfunded pension liabilities. The unthinkable can and will happen in the years ahead.
Private sector workers already know they are in charge of funding their retirement. In the years ahead, government workers will come to realise this too. As people live longer, they will have to save far more for their retirement.
The long term nature of this retirement trend indicates a bright future for the asset management industry.
The huge future demand for pension investments represents an enormous opportunity for asset managers worldwide.
Shane Brett is Managing Director of Global Perspectives, an alternative investment & asset management consultancy based in London & Dublin.