It is always comforting to read headlines that confirm one’s prejudices.
“Dumping equities in later life does not suit everyone” – FTfm July 25 – was such a headline. David Blake and Douglas Wright, professors at Cass Business School’s Pension Institute in London, argue that retirees should sell bonds to buy annuities and keep a significant equity holding until much later in life.
They have done the maths to back this up, but the headline also resonates with frustrated older savers who do not want to be pigeonholed as “risk averse” and herded into government bonds and similar “risk free” but low return assets.
First, the concept of moving from full pay to no pay is out of date: people in their 60s and 70s still have “human capital”, or earning capacity. They will increasingly have to use it since fewer of them will have generous occupational pensions. Second, their outgoings on mortgages and children are falling – positive for both cash flow and risk appetite.
Changes in individual perceptions matter because the “baby boomers”, born between 1946 and the mid-1960s, have started to reach retirement age, or the age when assumptions begin in the savings and investment industry.
These assumptions were already questionable. Andrew Smithers, of Smithers & Co, says the data on demographics and financial market trends show no correlation; and nor do changes in demographics affect savings rates. For instance, in the past couple of decades household savings rates have plummeted in both the US and Japan, despite their divergent demographic profiles. Factors that overwhelm the demographics include trends in asset prices.
But there is another reason why simplistic age-based assumptions should be treated with scepticism. Professor Richard Scase, of Kent University, says the baby boomer generation has changed every market it has moved through, from pop music to technology, but it has not done this as a lumpen mass.
His message is that age is a poor predictor of behaviour. It is better to think of people as “lifestyle tribes”, based on their attitudes, affiliations and financial state. Who would have predicted in the 1970s that “old” people would go to rock concerts? Or would research their diseases on the internet with the intention of influencing, or supplementing, their medical treatment?
What might this mean for investment trends? It should start to undermine the conventional wisdom that has driven money out of equities and into bonds. This will take time because other factors continue to drive asset allocation towards apparently low-risk securities. The latest example is the regulatory imperative, under new capital and solvency rules, for banks and insurers to increase their holdings of “quality”, “liquid” assets.
Disruption of the trend is most likely to be triggered by default on “risk free” assets. Don’t forget there are many routes to this outcome, including inflation and currency devaluation as well as writedowns and adverse changes in terms.
The inflation/deflation debate comes into this and is linked to the relentlessly negative press for Japan’s “lost decade”. A 1-2 per cent return on 10-year (and highly liquid) government bonds looks much better when prices are falling than the current negative real yield being offered in the UK, for instance. The high inflation/low growth of the 1970s felt worse, particularly for older people, than the Japanese approach to post-bubble deleveraging.
The self-reinforcing circle in Japan has been for public debt to replace private debt. Domestic savers have been prepared to fund the latter because they were getting both a real return on the assets and the social security that they wanted from the state. But important counter-inflationary forces, notably Chinese labour and a peace dividend, have run out of steam. If the bull market in government bonds ends, that would provide a nudge towards at least a more eclectic choice of assets. After all, if the interest rate on top-rated bonds starts to rise, the present value of liabilities in retirement accounts will fall, especially if inflation exceeds indexing caps.
So in western economies with a high level of social security and public debt, and a higher chance of inflation, the ageing cohort will be more likely to keep earning as the state and other benefit providers under-deliver, or even break promises. As investors they will seek assets that retain capital value. They may also increase borrowing by remortgaging their homes, joining the young in keeping private sector debt up, alongside attempts to curb public debt.
What might those baby boomers released from the shackles of risk-free investment pop into their equity portfolios? Income stocks with balance sheets stronger than their governments’ perhaps, alongside a few flutters on businesses that provide what they want: generic drugs, hearing aids, mobility devices, concerts and cruises, and web-based financial planning.
Jane Fuller, a former financial editor of the Financial Times, is co-director of the Centre for the Study of Financial Innovation