Cardano warns of negative impact on funding ratios in protectionist scenario

Funding levels for Dutch pension funds could potentially dip below 100% due to protectionist actions taken by the US and subsequent responses from other nations, as per a study conducted by asset manager Cardano.

Cardano releases a set of four macroeconomic scenarios annually for its clients, projecting trends over the following three years. These scenarios encompass variables such as GDP growth, interest rates, inflation rates, stock and credit market movements, and real estate developments. With many pension funds gearing up for a transition to a defined contribution (DC) system in 2026 and 2027, these scenarios have become increasingly critical in helping pension funds safeguard their funding ratios.

Of the four scenarios outlined by Cardano, two are particularly concerning for pension funds. In the ‘depression’ scenario, the funding ratio plunges to 73% due to a confluence of low short and long-term interest rates at 0.5% and a staggering 60% crash in the stock market. The ‘protectionism’ scenario, on the other hand, sees funding ratios declining from 120% to 97%, albeit still posing significant worries for pension funds.

Amidst growing geopolitical tensions between the US and China, and the escalation of protectionist measures like trade restrictions and tariffs, Cardano’s prophesized protectionism scenario appears to be unfolding. President Donald Trump’s aggressive trade policies not only target China but also extend to traditional allies like Canada and Europe, exemplified by recent announcements of tariffs on EU imports. These protectionist actions could spur a rise in inflation in Europe, slash global economic growth rates to 2% annually, and trigger a 30% decline in stock markets.

Pension funds, many of which have not yet mitigated their equity risks in anticipation of the transition, face heightened vulnerabilities. Equities-heavy portfolios are particularly at risk, with European equities projected to suffer more than their American counterparts in a protectionist market downturn. Despite market optimism aligning with a prosperity scenario, potential shifts catalyzed by protectionism could swiftly upend prevailing trends.

Given this landscape, many funds are contemplating protective measures like put options to shield equity portfolios from drastic price plunges. While the costs of such protections are relatively low, the regulatory confines within pension funds’ investment policies could restrict the extent to which equity risks can be curbed. Hence, adjustments in risk attitudes may be crucial for funds seeking substantial risk reductions that fall beyond existing strategic boundaries.

Overall, pension funds are navigating a complex and evolving financial landscape, where adapting to prevailing macroeconomic scenarios while maintaining long-term financial stability is paramount. As the specter of protectionism looms large, proactive risk management strategies that align with evolving global dynamics will be key for safeguarding pension funds against uncertainties in the financial realm.