Zero Interest Rates Put Pressure on Pension Funds: Crypto-Assets Provide a New Investment Avenue
Pension funds are under massive pressure. Zero interest rates and increasing stock market risks are threatening their business models. Pension funds need to find new investment avenues, and the blockchain asset class could be the perfect choice.
Pension funds are facing an existential challenge: Western societies are getting older and at the same time interest rates are hovering around zero. None of this will change in the foreseeable future – the central banks of the USA and the Eurozone have made this clear.
For pension funds, a low-interest-rate environment means that they may soon no longer be able to meet their payment obligations. Already today, many funds are massively underfunded. In the US, there was a planning deficit of USD 1.28 trillion in 2017 – more recent data is not yet available. In Europe, pension funds are also not in good shape. Of the 137 German pension funds, a third are under intensive observation by the Financial Authority BaFin.
Funds don’t hit their target rates anymore
The challenge of pension funds is their fixed income-focused business model. Their investment portfolios must generate an actuary assumed rate of return to have sufficient capital available to meet future payment obligations. This rate of return varies depending on the pension fund – the US average is 7.3 %. If a pension fund does not achieve its minimum rate of return, it won’t have an adequate amount of capital in the future.
In recent years, many pension funds could easily exceed their target rates, because of higher interest rates and a long bull run in stock markets. With COVID, the world has changed: Interest rates are back to zero, and there is great uncertainty in stock markets.
Especially the low interest rates are an enormous challenge. It is not unusual for pension funds to invest more than a quarter of their capital in government and corporate bonds – and depending on the pension fund, it could also be significantly more. With zero interest rates, most of these investments hardly yield any returns anymore.
Is leverage the solution?
So what do they do now? Fund managers must explore new avenues, but many pension funds have not yet decided what the new strategy will look like.
There are some rather bold proposals. For example, instead of reallocating funds to other asset classes, CALPERS – the largest pension fund in the US – wants to use higher leverage to invest in illiquid assets. Higher risk, higher return, right?
Right. But there is a much better approach than simply overleveraging portfolio assets. Instead, pension funds could also invest in crypto-assets.
Crypto-assets can increase risk-adjusted portfolio returns
Pension funds are probably not the first who come to mind as potential crypto investors. Yet, the asset class is the ideal addition for their portfolios.
First, crypto-assets would allow them to further diversify their portfolios, so that’s virtually the opposite of the proposed leverage strategy. Second, crypto assets have outperformed all other asset classes in terms of their risk-adjusted returns over the last five years.
Source: Woobull Charts
In other words: Crypto assets are exactly what pension funds need today. With a portfolio allocation of just 1 – 5% in crypto assets, fund managers can increase their annual return while keeping their portfolio volatility relatively steady. This has also been proven by various studies. Read more here: Study Shows: Even the Most Conservative Investors Should Invest in Blockchain Assets
It’s really just simple math. Pension funds should not try to beat the market now – hardly anyone has ever succeeded in doing so, no matter how many top-experts are sitting on the investment board. Diversification, on the other hand, has worked well for the last hundred years. So why reinvent the wheel now, when the market offers more than enough opportunities?