As inflation rears its head again, European pension funds may need to buy more stocks or face the risk of diminishing returns, after cutting equity holdings and buying bonds in the wake of the dotcom bubble burst and the global financial crisis.
Accounting standard changes and a regulatory push for better risk management have also encouraged the 5 trillion euro pension fund industry to adopt a liability-driven investment (LDI) approach aimed at matching assets to liabilities via a greater use of fixed income products. This has worked well thanks to low inflation and the "Goldilocks" assumption that the price environment will remain benign while the economy grows moderately.
The regulation changes did not oblige funds to slash stockholdings, but they have still loaded up on low-yielding fixed income at the expense of equities, whose long-term returns come with a risk of greater volatility in the short term.
But now inflation is climbing after a decade-long lull, and at such a rate that pension funds' investment strategy and performance may be reaching a turning point, requiring them to move into equities more.
Studies from the London Business School and Credit Suisse show world equities have delivered real annual returns of 5.5 percent since 1900, compared with just 1.6 percent for bonds. Surveys on inflation expectations show price pressures are expected to gradually rise.
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