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Mark speaks to the Sigma Partnership

February 10, 2010

The truth is that such optimism is dangerously unwarranted. The economic reckoning for the general public has yet to begin.

The public finances are in an increasingly dire state whilst the outlook for currency and bond markets remains fragile at best. Factor in the substantial risk of a sterling crisis and the very real threat posed to Britain’s triple-A gilts credit rating and the picture begins to become somewhat clearer, if not terribly edifying. As a nation we must acknowledge the seriousness of the economic perils that we are facing and plan accordingly as to how we can tackle the lasting legacy that this recession will undoubtedly leave in its wake.

The harsh truth is that only rapid action to correct the deficit will be the quickest route to the promotion of growth and recovery. After May any UK government will, of course, have its hands tied with precious little room for manoeuvre and as such the decision-making process for investors becomes even more crucial.

The simple truth is that the State will not be able to bail-out or top-up in the years ahead. A key example of the harsh reality of our new economic age will be highlighted in pension schemes. The scrapping of pensions benefits, falling equity and bond yields, lower interest rates, increasing life expectancy and even the risk of employers’ defaulting on pensions provisions all now combine to create a sobering economic outlook for those reliant upon such investments.

Defined benefit pensions schemes which fail to generate sufficient returns from the asset classes that they were invested in will, in all likelihood, suffer from the fiscal deficits left behind by this Labour government. Combine this fiscal reality with recent research from the Office for National Statistics, which suggests that six out of ten UK citizens are failing to contribute to a private pension or investment bond, and the present government’s failure to encourage personal responsibility is clearly highlighted.

A new emphasis based on promoting personal responsibility is sorely needed. Individuals must accept the importance of planning for their old age – put quite bluntly, reliable, adequate support to maintain living standards for future generations of pensioners to fall back upon will simply not exist.

Such pressing concerns are not merely focused just on the future but the present also. After all defined benefit pension schemes have already been ravaged by the effects of the credit crunch on the stock/bond markets and remain critically fragile. As a result the non-correlated returns profile of Alternatives such as private equity and hedge funds are increasing attractive to defined benefit pension schemes. Herein lies substantial risk.

It is appropriate to remember – not that I need to tell anyone here this! – that past performance is not a good guide to the future and one should treat with caution low-level advice to invest in Alternatives. Too frequently such advice is made by consultants on a narrow assessment of the expected return profile versus liability profile of the scheme without a proper assessment of the wider risks at play.

The potential for over-regulation or indeed bad regulation of the investment management arena also threatens to create moral hazard for investors. An incoming Conservative administration will not preside over the creation of such a system. Future regulation will not prevent all possible failures nor weed out rogue investments nor provide a bail-out for poor decision making. Government can only do so much – government should only do so much.

More than ever risks must be properly considered in the widest possible sense. Organisations and individuals alike should base investment decisions on a new combination of asset-liability matching and independent advice, provided by specialists, to ensure that risks are identified. Operational due diligence is thus only valuable if it is carried out by a broad, multi-disciplinary team of experienced professionals.

We must promote an approach based on the fundamentals. By taking simple precautions one can not only assess the full extent of our new financial landscape, but also identity the risks that will follow in the years ahead. Failure to mitigate against identifiable gambles would represent failure by fiduciaries to exercise stewardship responsibilities and the potential impact and cost of such mistakes will relentlessly increase to new heights over the next few years.

A multi-layered approach of encouraging personal responsibility, increasing the independent scrutiny of our volatile financial environment and raising awareness of the new risks of failure will together act as essential safeguards against the dangers of our new market place. Dramatic changes will continue to shape and re-shape our wider economy, yet amidst the gloom there are rays of hope. The victors at the forthcoming General Election have the potential to earn explicit consent to reshape the entire country, redefining government’s role in the domestic economy and Britain’s role in the world – it is a unique opportunity that we must seize.

Whilst government does have a role in stabilising and revitalising our confidence-battered economy, it will eventually be hard work, enterprise and freedom in the market place which will ensure that our economy thrives once again.