What impact does China have on your pension?
We’ve all heard the noises over the last few weeks of the Chinese stock market falling sharply. But China is over 5,000 miles away from Ireland, so how can events in China impact on a pension fund member here? Investment return is how.
Whether you are aware of it or not, some of your pension assets may be invested directly in China as an “emerging market”. However, more important is what’s known as the contagion effect – this is the reaction of the rest of the global markets to recent events. What happened in China impacted negatively on global confidence, causing equity (share) prices to fall in Europe and the U.S. In the last week in August, global equity markets actually fell -9.7% in local currency. This will impact on pension fund values that have any exposure to equities.
So what did happen in China?
Effectively, China’s retail driven bubble burst and their equity market suffered a 47% drop in value. However, when taken in relation to their 200% growth since September 2013, this drop looks less catastrophic. The Chinese government took swift action, devaluing the local currency and lowering interest rates. However, global markets had already reacted negatively and there is now international acceptance that Chinese economic growth, while positive, is running well below official estimates.
We all know that equity markets are volatile and will rise and fall. In recent years, as interest rates and bond yields dropped, some investors have been driven to the stock markets and equity funds in the search for investment returns. However, these investors have very little tolerance for downside risk. This has resulted in short term investors selling their shares at the first signs of weakness in currency and equity markets. For pension investors, it is not helpful to focus on the short term as this can lead to investment decisions which are not appropriate for the longer timeframe of your pension fund.
In a world where the majority of active pension scheme members in Ireland are now in defined contribution arrangements, the amount of pension provided at retirement is based on the value of your fund, so any rise or fall in world markets can directly affect the amount of pension you receive.
Pensions are a long term investment
When looking at pension fund investments, it is safer to focus on the fundamentals which drive markets over the medium to long term. It is worth repeating, pensions are a long term investment. In recent years, investment terms can be as long as 60 years. For example, if you join your pension scheme age at 25 and invest for 40 years to age 65, you then have the option of continuing the investment beyond retirement which could be for a further 20 years. Therefore, as a pension scheme member, you need to focus on your long term financial plan and ensure that your investment choice is appropriate for your plan and your appetite for risk. Know your investment choices and engage with your pension provider.
As well as the ability not to panic and remain focussed on your long term goals, a key to a successful investment plan is diversity. This means that you don’t put all your eggs in one basket and spread your investments over a wide range of asset classes. Most pension schemes in Ireland now offer members a multi asset fund choice which includes different asset classes as well as different investment managers. This strategy reduces volatility and lessens the impact of a sharp fall in markets. On the other side, you will also not benefit from any large rises in markets. The aim from your pension investments should be a steady positive return over the long term.
A solid diversification strategy will result in smaller impacts when market shocks happen in a single market, as they did in China.
In addition to diversity, most pension arrangements now offer members an investment strategy usually called “lifestyling” which reduces their exposure to investment risk as they approach retirement. For members that will be taking a pension/annuity at retirement, this strategy may include an element of transferring assets from growth funds to cash and/or bond funds. Some pension schemes may offer members a strategy which caters more for those who may be considering the option of the Approved Retirement Fund (ARF) at retirement. For these members, there is a reduced requirement to de-risk as the investment path continues beyond retirement date.
With regard to investment markets, the US is still the engine of the global economy and is relatively strong. Outside the US, the outlook for growth is low; however, global monetary policy continues to be very accommodative with developed world interest rates close to zero. Members should focus on the long term. Short term falls in markets have less impact that the negative headlines would have you believe. Remain focussed on your long term financial plan and continue to engage with your pension provider.