Adair Turner, a speaker at the marcus evans European Pensions & Investments Summit 2014, shares his outlook on the economy and what implications it may have on investors
LONDON, Apr 17, 2014 - (ACN Newswire) - A drop in interest rates in the past 15 years has induced a "ferocious 'search for yield uplift'", making some pension fund investors "susceptible to claims that clever financial structuring could deliver additional yield without apparent additional risk," according to Adair Turner, Former Chairman, Financial Services Authority (FSA). "With extra returns almost always comes greater risk. Returns have to be earned by taking controlled and carefully managed risk," he says.
Lord Turner is a speaker at the marcus evans European Pensions & Investments Summit 2014, in Montreux, Switzerland, 28 - 30 April.
- What drove the financial crisis of 2008 and what factors are critical for a stable and growing economy?
Ahead of the 2008 crash, many central bankers and regulators believed that the global economy and financial system had become more stable, that a "Great Moderation" reigned. The orthodox assumption was that achieving low and stable inflation was sufficient to ensure macro-economic stability; and that financial innovation, securitisation, structuring and derivatives had increased the resilience of the financial system.
But it all ended in disaster. The fundamental drivers of that disaster were: (i) a sustained rise in real economy private sector leverage, with private credit growing relentlessly faster than nominal GDP; (ii) an explosion of complexity within the financial system which, far from making the system safer, increased the danger of self-reinforcing reflexive reactions between different credit and derivatives markets which resulted in first excessive exuberance and then a collapse.
To ensure a more stable economy, central banks need to be focused not just on low and stable rate of inflation, but on the control of the credit cycle.
- What lessons did pension investors learn from the crisis? Were they guilty of "pre-crisis delusions"?
There is no free lunch. With extra returns almost always comes greater risk. Nominal and real interest rates fell relentlessly in the 15 years running up to the crisis. In 1990, a pension fund could buy a 20-year GBP or USD index-linked bond giving a guaranteed real return of over three per cent; by 2007 the equivalent was 1.5 per cent. Not surprisingly, this induced a ferocious "search for yield uplift". That made some pension fund investors susceptible to claims that clever financial structuring could deliver additional yield without apparent additional risk.
And that helped drive the uncontrolled growth of real economy credit packaged into apparently low risk securities, particularly in the US.
- Global economic activity strengthened in the second half of 2013. What is your growth forecast? What vulnerabilities still need to be managed better?
The US economy is now recovering reasonably well - but with a very low rate of employment. The UK is also recovering, but in a very unbalanced fashion, too reliant on house price increases and on London's extraordinary success. The Eurozone faces the real danger of deflation, and the ECB will need to take offsetting measures. 2014 is the crunch year for Abe-economics: the April sales tax increase may produce a significant slowdown; expect to see still more radical stimulative action from the Bank of Japan.
But the most important economy to watch is China. Since 2008, growth has been sustained by extraordinary credit growth. The authorities know they need to slow the boom down, but achieving a soft landing is very difficult. If they do not manage the transition well, China could be the origin of the next financial crisis.
- What implications does that carry for pension funds and other asset managers in Europe?
We are in a period of very low nominal and real interest rates on risk-free or very low risk bonds. In the Eurozone and Japan that will remain so for many years; even in the US and UK rates may stay lower for longer than some market participants now think.
Returns therefore have to be earned by taking controlled and carefully assessed risk. Long-term infrastructure financing should provide opportunities for superior yield based on operating cash flows rather than "innovative" structuring. Higher yield dividend stocks may provide good long-term value. Focus on sustainable real economy investments: beware the complex highly leveraged structures which are bound to proliferate the longer ultra-low interest rates last.
About the European Pensions & Investments Summit 2014
This unique forum will take place at the Fairmont Le Montreux Palace, Montreux, Switzerland, 28 - 30 April 2014. Offering much more than any conference, exhibition or trade show, this exclusive meeting will bring together esteemed industry thought leaders and solution providers to a highly focused and interactive networking event. The Summit includes presentations on increasing fund resilience, establishing a robust risk framework, capturing investment opportunities and assessing the true value of emerging market investments.
For more information please send an email to info@marcusevanscy.com or visit the event website at www.epi-summit.com/AdairTurnerInterview
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