Reality Check for Pension Fund Providers

European Pension Funds need a return of more than 8% a year to meet their obligations over the coming decade says a Financial News survey. We can only wish them good luck. Not that we think that this performance target is totally illusionary. We just think that it is not very prudent to construct the industry on the basis of these optimistic assumptions.
If the markets provide a positive surprise, fine. But do not promise your current and future pensioners payments that depend on fancy projections. Either the pensioners or your shareholders (who may have to make good any shortfall in the pension fund) will be disappointed.
Long-term equity returns consist of (1) dividend payments and (2) the growth rate in company earnings (which are closely related to overall economic growth). Mature Western Economies with stable or even declining populations will be lucky to produce real growth of 2% per annum. Add to this the paltry dividend yield and you are far short of the 8% return goal.
Bonds are not much help either with nominal yields hovering around all-time lows of roughly 4% on average.
Attempts to achieve better returns in alternative assets - especially Hedge Funds - may be offer some help for those funds skilled (or lucky?) enough to pick the winning funds but will offer no solution to this basic lack of returns that the industry as a whole faces. The only sustainable solution is to offer lower future pensions, raise contribution levels or a combination of both. Attempts to squeeze the costs of pension fund management and administration may also be helpful in a marginal way.