By Sohini Chowdhury, senior economist at Moody’s Analytics

What if the US government suddenly implemented a high carbon tax on every portfolio manager from January? Or what would happen if a disorderly transition policy in high carbon taxes are imposed, but only in 2030? As 2022 draws closer, the investment reality for US asset managers is that future funding levels will depend on answers to these potential scenarios over the short to medium term.

With this in mind, there has never been a more pressing need for intermediate assumptions about the future performance of capital markets which come from a coherent and realistic models. After all, the probability of certain asset prices either rising or falling significantly in value could very well depend on these models.

But as ever with forecasting models, it is all a question of timescale. The reality is that pension funds and DC planners do not want to know specifically that what their distribution of US equities is in a decade’s time, they instead want to know how much their current pension pot is going to be in ten years’ time. There could be a case, for example, where a clients need to speak to their pension planners about the various levels of funds going into their pension schemes. In this sort of situation, the firm in question needs to help their clients understand the specific nature of their pension schemes and what the consequences of their choices could be.

Ultimately, these choices will be affected by funding levels which depend on the way the capital markets evolve over the short to medium term. This is why simulations are needed that to show intermediate market assumptions coming from a coherent and realistic model. If, as a case in point, someone has a pension pot with Aviva and they decided to login to the website, they would get a set of distribution outcomes. These outcomes could include a projected value for a pensions pot at 300k, as opposed to 500k when someone retires. Based on this analysis, the individual in question can make a number of decisions – including deciding to invest in something less risky. Or, alternatively, they may decide that they need to work for eight to 10 years longer and retire a lot later.

As we move into next year, these same sorts of decisions will need to be made by asset owners, the only difference is they going to need to have a range of different investment options open to them. Ultimately though, these institutions need to be much better informed before they make these decisions. In order to do this, they need to be able to create coherent and realistic simulations of the capital markets which can then be linked directly to a pension scheme. Only then can asset managers subsequently allow their consultants to carry out the required advisory work around those pension schemes to enable their clients to make more informed decisions.

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