Population Aging and Investing
Some of my readers like my submissions that are industry focused: commuted values, saving for retirement, etc. Other readers like when I leave the trusted path and rant about things farther afield like education or telecommuting. Still other readers just like to smile at the cartoon and delete the email without clicking the link. After a few weeks (now months) of diversion with COVID-19, it’s time to get back to the nuts and bolts.
Every once in a while, the Canadian Institute of Actuaries publishes a paper by one of our members and my friend Michel, who is a die-hard supporter of our organization, wishes there were more. The most recent paper from the CIA is a joint publication by the CIA and our strategic partners the Society of Actuaries and the Institute and Faculty of Actuaries (UK). The paper The Connection between Population Structure and Bond Yields is a short 33 pages but is jammed with some hard thinking and semi-difficult math. The paper also has pretty graphs which help the less technical among us visualize the work.
In a nutshell, the paper ‘proves’ that as a population ages, bond yields decline. Many are well aware that in Canada we have had 30+ years of declining bond yields (my entire career) and it’s also no secret that with the baby boom ending back in 1964, the last 30 years has seen a continuous aging of our population. Although published after the fact, this work is one of the pillars of the CIA’s 2019 paper Retire Later for Greater Benefits: Updating Today’s Retirement Programs for Tomorrow’s Retirement Realities which I wrote about here. That earlier paper exposes the reality that lower investment income and longer lives will drive workers to stay on the job longer before they will be able to afford retirement.
A reminder to readers that correlation does not necessarily mean causation – but since it’s hard to believe that declining bond yields cause people to have fewer children, I’m going with the more obvious answer that fewer children and an aging population (even with immigration) drives lower bond yields. This makes complete sense when you think about the fact that older savers are advised to transition their savings from equities to bonds and those buying target date funds and annuities are transitioned automatically.
With long-term bond yields approaching zero these days and the continued march of an aging population in Canada, I am trying to imagine how this story will progress going forward. Japan, a population older than Canada, saw their interest rates go negative in 2016 and I worry that is where we may be headed. On the other hand, our government is printing money faster than the kids racing their cars on Toronto’s highways and that worries me that we are about to see rising inflation and increasing bond yields as investors ask to be compensated in real dollars. My friend Malcolm says I worry a lot.
If we leave for a moment the effort to predict where bond yields are going in the future and just assume that the paper is giving us an important signal that as our population ages it may not be upward, and if it is it may well be an anemic climb. Starting with that understanding it might partly explain why many of us consider the rise in stock markets around the world since March 23rd exuberant and irrational. Economies are facing huge unemployment as a result of COVID-19 so to me the only rational answer is that investors are rushing to buy something that will generate a positive return since bonds are essentially dead.
When individual investors over-pay for equities, it subsidizes the success of careful long-term investors just like individuals that invest heavily in lottery tickets subsidize more conservative taxpayers. Nonetheless, I worry that we are setting up novice investors for economic ruin by enticing them to pay for their retirement with risky investments that may not pay off. This is the constituency most hurt by the demise of defined benefit plans. On the other hand, I worry that no one really wanted to absorb the CIA paper on postponing retirement because it was a message they didn’t want to hear. Maybe I do worry too much.
Setting aside my fears for novice investors, no one should have missed the story about the Alberta Investment Management Corporation losing $4 billion, allegedly investing in a strategy that sought to boost returns. It still amazes me that there are highly educated professionals that think there is a way of generating a return greater than the ‘risk free rate’ without taking risks. Generally, when someone thinks they have found such an investment it is either a Ponzi scheme or an opportunity to make a little bit of money most of the time with a huge tail risk of losses if things go sideways. While you might want to forgive the investment managers for not predicting COVID-19 – the point to prudent investing is to not take the risks you cannot afford and to prepare for the unexpected since that is the whole point to risk – it’s about uncertainty.
The big worry here is that it’s not just the novice investors that are taking risks that cannot be afforded but it’s also our collective pension funds. I worry that taxpayers and the lowly worker will pay the price if the super-well-compensated investment gurus blow up our savings.
I do worry too much but closing my eyes and hoping it all works out feels more uncomfortable to me.