Conventionally, in the framework of the Capital Asset Pricing Model, ‘alpha’ would refer to excess riskadjusted return (a nice thing if you can get it!). In practice, the term seems to be deployed rather loosely, being used variously to cover allocations to assets whose returns have in the past been relatively uncorrelated with a fund’s liabilities; leveraged – that is to say, risk-enhancing – plays across almost any asset class; and giving greater freedom to fund managers. For pension funds, one motivation has probably been to diversify asset portfolios, perhaps evidenced by bigger allocations to private equity, commodities etc. Another motivation, both here and overseas, seems to be to try to close deficits partly by earning high investment returns on some proportion of their asset portfolios. Cast in that light, it appears to be part of the broader ‘search for yield’, which has been offered by some as contributing over the past couple of years to the compression in credit spreads and other market-based indicators of risk, such as the price of options on most asset classes. Two responses to this have circulated amongst market participants, both intermediaries and asset managers. One is that falls in implied risk premia truly have reflected a reduction in risk. The other is that, while that story might hold up to a point, risk has been under-priced. It is certainly plausible that structural change has caused risk to decline somewhat over the past decade or so. First, monetary policy regimes have become more credible.
Companies have acted to repair balance sheets following the excesses of the late 1990s, and may conceivably have built a cushion of financial assets to support them through a period of uncertainty as they adjust to the new competitive forces associated with globalisation. But the UK corporate sector stands out as having employed its surplus in ‘cash’ to a far greater extent than its G7 peers (Chart 6). The IMF hypothesise 1 that this may have been motivated by a desire to accumulate a precautionary pot of liquid savings for managing pension fund deficits. I do not know whether or not that is so. For example, the build up of deposits has been concentrated in a few sectors: real estate, and business services, and it is not obvious that these sectors have big pension fund deficits (Chart 7). But that pensions have been a material component in firms’ cash management is not in doubt. That is apparent in the share of gross corporate savings accounted for by employers’ contributions to pension funds (Chart 8). Contributions have tripled – or in real terms doubled – since the late 1990s (Chart 9) 2 . Part of this reflects ‘special’ or ‘one-off’ contributions to reduce deficits. But, judging by selfadministered schemes 3 , regular contributions have doubled (Chart 10). What is going on here? Well, it might have something to do with your management of risk, bearing in mind avoidable and unavoidable sources of uncertainty.