Is it possible for an investment to be both cheap and expensive at the same time?
The Schrödinger's cat thought experiment involves a scenario in which an unfortunate cat is presented to be simultaneously both alive and dead. I’m told this has something to do with physics. Not my area unfortunately. But if a cat can be alive and dead at the same time, is it possible for an investment to be both cheap and expensive at the same time?
According to information published by the Pensions Regulator, UK defined benefit pensions schemes currently hold a combined total in excess of £600 billion (around 50% of the total) in investments which do not move in line with their liabilities. Being unhedged has hurt many schemes, with their combined solvency deficit increasing from £430 billion in 2010 to £800 billion in 2015 despite jaw dropping levels of deficit contributions over the period.
All schemes are well aware of this mismatching risk due to painful experience. What they really want is to be holding assets which do move in line with their liabilities, they just haven’t deemed it affordable to buy those assets yet. Under this view, matching investments would be great but they have been too expensive to consider. My personal view is that matching investments are expensive – but they could also be viewed as cheap.
How can this be? Well, interest rates have been consistently falling, meaning pension liabilities have been going up and up, but also that matching assets have been getting consistently more expensive for the last 25 years or more. Even though this keeps happening, the market seems to consistently underestimate how much more expensive matching assets are going to get. For example, over the last 25 years:
Like the housing market, those waiting for prices to stabilise or fall run the risk that the market just keeps moving away from them. The point is: even though an asset is far more expensive to buy than yesterday, it could also be far cheaper than buying it tomorrow. Hence both cheap and expensive at the same time. I for one can’t think of any scheme which already de-risked and is now regretting having done so. The best time to buy could be now.
This article represents the views of the author only, and does not necessarily represent the views or professional advice of KPMG in the UK.
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