Over the next decade, the pensions industry will be faced with a dilemma. The transition to mark-to-market accounting and capital adequacy requirements will put pressure on pension funds to hedge their liabilities and reduce their risks. However, longer life expectancy and relatively low return expectations will place heavy demands on investment policy, which can be met only through adoption of a riskier investment policy. The pension funds able to solve this dilemma will emerge as tomorrow’s winners. One way of solving it could be through increased focus on hedging of liabilities, while at the same time underpinning returns by a ‘smart’ portfolio, in combination with a multi-strategy portfolio.

Another challenge facing the industry is the issue of how to turn the change from collective defined benefit schemes to individual defined contribution schemes in a more constructive direction. Higher costs mean that individual defined contribution schemes must be expected to lead to lower pensions in the future – and therefore, they are no safe bet looking forward. A new collective product that can offer security, predictability and a high real return is much in demand. It is time for investment driven liabilities.

It seems to me that asset owners already have and will have more and more to tackle three issues: the first is to ask if there is a point at which the diversification of a portfolio we are all looking at increases the risks instead of reducing them. Second, what does being a ‘long-term investor’ – which is particularly the case for reserve funds like us – mean in practice in a financial world that is becoming more and more short-termist?; and thirdly, even if our fiduciary duty is tomaximise return within a risk budget, could we really neglect the inclusion of ESG issues into investment analysis and decision-making processes?

The challenge for pension funds over the next 10 years will be to recognise that asset class lines will become less important. As pension funds continue to separate alpha from beta – seeking beta drivers for efficient markets and alpha drivers for inefficient markets – asset class lines will blur. In the past, alpha was captive to beta as pension fund managers were directed to squeeze alpha out of their strategic benchmarks.

This is the last place alpha should be looked for because strategic benchmarks are designed to be efficient, so trying to extract alpha by beating benchmarks can be very tough.

Alpha will no longer be captive to beta and pension funds will seek investment outcomes based on risk and return properties rather than strict asset class lines.

The other implication is that pension funds will become more sophisticated in developing and spending a risk budget. Separating alpha from beta is not enough to ensure success. Recent regulations in the UK and the Netherlands highlight the requirement for risk-based capital.

The FTK system in the Netherlands will require pension funds to contribute more to their national pension protection funds for riskier investments. So, alpha per risk unit will become of critical importance. This will require an efficient application of risk budgets.

The next decade will be nothing less than the continuing quest for exceptional investment performance. A clear vision on the role of risk management in the financial markets will be key to achieving lasting success. We see three dominant trends emerging out of risk management: product innovation, partnerships and compliance.

Product innovation will continue its flight forward. Risks will be further unbundled, assets securitised and derivatives tailor-made. The set of investment opportunities will continue to expand at a breathtaking pace. This will allow us to combine the risks we really want, creating the returns we really need.

Unbundling of risk, combined with organisations focusing on what they are good at, create the second trend: new, unconventional partnerships. Beta exposure will simply become a supermarket commodity, alternative alpha or beta strategies will be developed and/or offered with a new group of organisations while investment banks and asset managers lose their traditional predominance. Institutional investors will enter into a whole new range of partnerships, combining their strengths with specialised organisations that cater for one specific source of risk and return.

Product innovation and new innovative partnerships will further trigger new challenges for compliance and control. More new products will become part of the investment strategy that do not fit in the regular control framework. It will become increasingly difficult to deliver traditional “in control” statements, increasing the importance of a thorough and flexible role of compliance in the asset management industry. Successful investors will find novel ways to be in control, while regulators shift more towards a principle-based compliance framework.

The asset management of pension funds will be put under increased pressure by more intense regulation and procedures. This will not encourage innovation. In the hunt for finding the best to do the job for a decent price, more work will be outsourced to the real specialists who can add value. More asset management firms will have a stock quotation, and consolidation will lower the number of names.

More mandates will be based on only a performance fee, bringing more alliance of interest and therefore transparency to the market. There will be a strong trend towards more fiduciary management.

The upcoming decade will show ever-increasing attention to socially responsible investments. More pension funds will find that SRI issues are important for risks and returns in the long run.

There will be better back office and management information systems: real-time management will become the ‘best in class’. Pension funds will be paying out pensioners not only in money but also in services like inexpensive healthcare. The Netherlands will show the world that DB or collective defined contribution is superior to DC. In 10 years time PME may be part of a larger entity. The fund will engage in European activities because most of the employers have a European or worldwide business and pensions must be portable.

Pension fund administration and member services will be entirely web-based and real-time. This makes it possible to shift large volume administration and services to a genuine individual level. More and more money will be allocated into emerging markets. New markets will emerge.

It is hard to look forward 10 years whilst writing on the eve of the publication of UK government's white paper on pensions. It is possible that there will be a thriving extra tier of state pension provision, bringing funded pension provision to millions more workers through auto-enrolment into a national scheme. Or perhaps into ‘super trusts’ which grow out of today’s schemes. By 2016, hundreds of pensions professionals could be gainfully employed sorting out the resulting mis-selling scandal if means-testing of state benefits is not tackled. But let us hope we have something more productive to do.

By then, stock markets may finally be coming to the end of a 16-year bear market, a repeat of the doleful period of 1968-1982. A resurgence of world inflation, as a billion Chinese consumers are finally allowed to spend some of their earnings instead of lending them all to the West, will be greeted with relief. The shift from DB to DC will largely be complete by 2016 and the pendulum may not yet have started to swing back the other way. Railpen now provides pension entitlements to one-third of a million people on behalf of 240 companies. I expect there will be further changes in the next 10 years, but the low costs and good governance which multi-employer arrangements can offer make sense in any environment. Let us hope that by 2016 there will be more super trusts.

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