Watson Wyatt’s Global Pension Assets Study also reveals that the global pensions balance sheet (measured by asset values over liability values) deteriorated by around 29% in 2008, reflecting the combined effects of poor performing assets and lower government bond yields.

Roger Urwin, global head of investment content at Watson Wyatt, said: “While the ramifications of this global economic crisis will be played out for many years to come, the striking deterioration of solvency levels around the world is testament to the hidden risk contained in the global system; emphasized by the speed and extent of the contagion. The pensions system is being tested on every level. Most notable in 2008 were the impacts on it of credit and collateral risk as well as greater issues around liquidity and volatility. These have been exacerbated by the underperformance of many investment managers relative to their benchmarks. We have seen some successes from persification and hedging strategies. But overall we see an industry facing a mountainous challenge.”

According to the study, pension assets now amount to 61% of the average GDP down from 72% ten years ago which takes the measure back to levels last seen in 1996.

Roger Urwin said: “To meet the demographic crunch ahead, countries need the advanced funding of pensions to grow relative to the size of their economies. This data shows a worrying picture. While this decline is offset in some countries by the development of sovereign wealth funds, we should remember that SWF’s amount to only around a tenth of the size of global pension fund assets. This is a wake-up call for governments worldwide to engineer bigger allocations to pension savings.”

Other highlights from the report include:

Ten-year global asset data for the P11

• Until 2007, global pension assets had more than doubled in the previous ten years, growing at a Compound Annual Growth Rate (CAGR) of 7.1%. But this year’s results have reduced the ten-year CAGR to 3.7%.
• Despite losing market share in the past ten years the US, Japan and the UK remained the largest pension markets in the world, accounting for 61%, 13% and 9% respectively of total pension global fund assets
• Australia is the fastest growing market, now fifth largest in the group
• All countries in 2008 saw significant negative growth in pension assets, except Germany which was helped by its high allocation to bonds
• In terms of ten-year CAGR (in local currency terms), these remain mostly positive, with Australia (12%), Hong Kong (10%) and Germany (6%) having the highest and Japan (-1%), Switzerland (1%), Canada (3%) and the US (3%) having the lowest.

Asset allocation for the P7

• In the five years to 2008 equity allocations among the P7 markets have fallen from around 51% to 42%, having reached a high of 60% in 1998. During the same period bond allocations increased to 40% from 36%.
• Other assets, especially real estate and to a lesser extent hedge funds, private equity and commodities, have grown from 12% to 17% in recent years

Roger Urwin said: “Last year’s events presented pension funds with very difficult strategic asset allocation choices. Some funds were pressured to actively reduce equities and increase bonds to address solvency issues. Many more were prepared to allow their asset allocation to drift out of equities and into bonds by not trading and simply staying on the sidelines. Some maintained a discipline in their strategic mix and rebalanced to prior equity percentages. The net result though has been for the historic overweighting to equities largely to disappear but not through a measured de-risking process. Funds face a difficult choice between looking for de-risking opportunities or re-building risk allocations. Whichever route they take, they are likely to continue to favour multiple asset classes and increased persification as they seek to work their assets harder to meet liabilities.”

Global liability [1] data for the P11

• Global pension funds balance sheets suffered significantly by on average 29% during 2008 as assets shrank markedly and liabilities increased.
• This compares with the prior five year period when funds on average enjoyed improvements of the order of 4% per annum.

Roger Urwin said: “Severe market events last year put the global balance sheet under greater pressure forcing solvency levels for many funds to unprecedented lows. This will have caused serious disruptions to pension funds’ journey plans. There are a number of options on the table – extra contributions from sponsors, contingent funding arrangements, investment strategy reviews, hedging strategies and buy-ins, not to mention changes to benefits structures. But finding solutions attractive to all parties will not be easy.”

Defined Benefit (DB) vs. Defined Contribution (DC) for the P7

• During the ten-year period from 1998 to 2008, the CAGR of DC assets was 7.5% against a rate of 1.4 % for DB assets
• DC assets now comprise 45% of global pension assets compared with 30% in 1998
• Australia has the highest proportion of DC pension assets, having increased them from 76% to 88% of overall assets between 1998 and 2008
• The countries that show a larger proportion of DC assets than DB assets are the US, Australia and Switzerland while Japan, Canada and the Netherlands are close to 100% DB.

Roger Urwin said: “The year when DC assets overtake DB assets is approaching. Despite this growth, the innovation in DC strategies has not kept up. DC investment approaches often seem rudimentary and expensive.

Following a year of unprecedented events, it is worth re-thinking the part effective governance plays in meeting the multiple challenges of the pensions industry. The more complex environment for pension fund decisions has now to consider new developments in risk, regulation and the investment landscape. It appears that the ‘governance gap’ - the margin by which the time and expertise of pension fund boards potentially falls short of what is required - has grown larger. This argues for new initiatives in governance resources and structure. Otherwise governments will have to acknowledge that pension saving shortfalls could worsen. Every way we look at it, stronger governance is critical for pension funds to bounce back in 2009.”

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[1] Liabilities can be measured on a number of different bases. In the report we used long Government bond discount rates to make global comparisons easier. These figures will not coincide with measures used in accounting where AA bonds are generally used, or the measures used for funding purposes where rates usually take some account of the expected returns from equities.