top of page

Why pension fund managers are reducing stock market exposure...

Why pension fund managers are reducing stock market exposure…

Brendan Greenwood, CFP, CIM, B.Comm | May 10, 2023

What is happening with the economy?

The global economy has been in a state of flux in recent years, and one of the primary drivers of change has to do with shifting monetary policies of central banks and growing government debts. These changes have had a significant impact on the world's financial markets.

Loose monetary policy accelerated consumption and the amount of money chasing assets contributing to higher than normal inflation and higher stock market prices. Governments reversed course last year and began raising interest rates, increasing borrowing costs, slowing down economic activity. This, in turn, can lead to a decline in stock prices, as investors become less optimistic about the future prospects of corporate earnings. State street measures the risk sentiment amongst institutional money managers and notes it hasn’t seen three consecutive months of negative readings since 2015.

Are stocks overpriced?

Let’s look at the S&P 500, a major US stock index as our proxy for the stock market. The S&P 500 tracks the total market capitalization (share price) of 500 of the largest companies in the US. The cyclically adjusted price earnings (CAPE) ratio of the S&P 500 can help us gage whether the stock market is over-valued. CAPE looks at the 10-year average real earnings of all the companies in the stock index and compares them with the current stock price of all companies that make up the index. The higher prices are relative to 10-year average real earnings the more expensive stocks are. Currently the CAPE ratio is around 29 compared to a long run average of 15 going back to 1957.

The current CAPE ratio highlights a stock market that is still richly valued, trading near valuation levels that preceded the 2007-2008 financial crisis. Elevated market valuations and rising interest rates have led to a fall in the equity risk premium, a measure of the excess return the stock market provides above the risk-free rate. The risk-free rate represents the interest an investor can expect from a risk-free investment over a specific period.

The equity risk premium has fallen dramatically leading asset managers to start considering alternatives that provide a better risk-reward trade off.

Where is the smart money going?

Pension fund managers typically are more vigilant in how they manage money because of their promise to deliver a defined benefit. Over the past several years due to falling interest rates they’ve had to take on increasing risk to generate enough return to meet their pension liabilities. In the current higher interest rate environment pension fund managers can reduce their risk and earn just as much. In the face of a looming recession pension managers are reducing their stock market exposure. In some cases, to 50% and in more extreme cases much lower. AON a global management consulting firm that advises pension fund managers, in it’s modelling of possible stock market outcomes included a scenario involving a 50% decline in stock values over 3 years without an immediate rebound.

Most notably pension fund managers are increasing their exposure to inflation sensitive holdings such as commodities and private infrastructure. Allocations are also being increased to publicly traded bonds as well. Institutional managers believe higher interest rates are likely to persist for the intermediate term. It would serve your portfolio well to evaluate the percentage held in stocks and the types or stocks held. For example, in higher interest and inflationary environments value has historically outperformed growth stocks that tend to have valuations dependent on future cash flows. If you’re reducing the percentage of money allocated to stocks, you need to assess what alternatives make the most sense.

Brendan Greenwood is an Investment Advisor and Financial Planner with Worldsource Securities Inc. specializing in tax advantaged personal pension strategies and low volatility investing for professionals, incorporated individuals, business owners, retirees and their families.

For other articles written by Brendan Greenwood visit his Blog | GreenwoodWealth

To book a discovery meeting with Brendan to see if we can help visit Contact | Ontario | Greenwood Wealth

Investing involves risk. Equity markets are volatile and will increase and decrease in response to economic, political, regulatory and other developments. The risks and potential rewards are usually greater for small companies and companies located in emerging markets. Bond markets and fixed-income securities are sensitive to interest rate movements. Inflation, credit and default risks are all associated with fixed income securities. Diversification may not protect against market risk and loss of principal may result. Commissions, trailing commissions, management fees and expenses all may be associated with investing in exchange-traded funds (ETFs). Please read the relevant prospectus before investing. ETFs are not guaranteed, their values change frequently and past performance may not be repeated.

This material has been prepared for informational purposes only and should not be considered personal investment advice or solicitation to buy or sell any securities. As well, it is not intended to provide, and should not be relied on for, tax, legal or accounting advice. It may include information concerning financial markets as at particular point in time and is subject to change without notice. Every effort has been made to compile it from reliable sources, however, no warranty can be made as to its accuracy or completeness. Investors should seek appropriate professional advice before acting on any of the information here. The views expressed here are those of the authors and writers only and not necessarily those of Worldsource Securities Inc., its employees or affiliates. There may also be projections or other "forward-looking statements." There is significant risk that forward looking statements will not prove to be accurate and actual results, performance or achievements could differ materially from any future results, performance or achievements that may be expressed or implied by such forward-looking statements and you will not unduly rely on such forward-looking statements. Before acting on any of the information provided, please contact your advisor for individual financial advice based on your personal circumstances. Worldsource Securities Inc., is the sponsoring investment dealer and the member of Investment Industry Regulatory Organization of Canada and the Canadian Investor Protection Fund. Insurance strategies and solutions are provided by Brendan Greenwood as part of comprehensive financial planning through Pelorus Transition Planning.

336 views0 comments


bottom of page