In a low-growth world, even pension funds chase riskier investments

The sluggish growth gripping the world isn’t just harmful because it hurts economic output. It also pushes investors into taking ever-greater risks

 
Snapdeal co-founder and CEO Kunal Bahl.
Snapdeal co-founder and CEO Kunal Bahl. (Money Sharma/AFP/Getty)

On September 12, an Indian e-commerce company called Snapdeal changed its logo and announced that goods from its marketplace would be shipped in vermilion boxes. It likely was desperate move to gain attention of shoppers. The closely held start-up is said to be worth about $6.5 billion (US), a hefty figure. But Snapdeal is only India’s third-biggest seller of stuff over the Internet—and it is falling behind the leaders. That valuation probably is shrinking.

Why should a reader of Canadian Business care about a fading Indian unicorn? Because a large group of Canadians has a stake in Jasper Infotech, the company that runs Snapdeal. In February, Ontario Teachers’ Pension Plan bought shares in Jasper worth US$200 million. Teachers’ won’t comment on the investment, but it is fairly obvious what is was thinking. Goldman Sachs predicts India’s ecommerce market will be worth $300 billion (US) by 2030, by which time the country will have more than one billion Internet users, compared with about 462 million today. Money will be made and Teachers’ decided to take a chance: Fortune favours the bold, right?

Not that pension funds have much choice but to be brave these days. With interest rates around the world pinned near zero, the only way to make a return that matches their obligations to their pensioners is to chase yield. That’s not necessarily a bad thing. As Carolyn Wilkins, the No. 2 at the Bank of Canada, noted in a speech in London on Sept. 14, Canada’s pension-fund managers are highly skilled and they have the scale to ride out short-term volatility. But there is still something slightly discomfiting about the sight of formerly staid pension funds operating like venture-capital firms. “Pension funds are often large participants in the financial system, as they are in Canada, and so risks in this sector merit careful monitoring,” Wilkins said.

It has become clear that the world was changed by the financial crisis. In 2005, the potential annual growth rate of the global economy—the rate at which there is no upward pressure on inflation—was 5%. The Bank of Canada estimates potential growth now is just over 3%. The difference amounts to a loss of output this year of US$1.5 trillion, according to the central bank. If global economic growth fails to pick up, foregone output will rise to US$9 trillion in five years, Wilkins said.

Potential growth is determined by the size of the labour force and productivity. Pools of active workers in advanced economies are shrinking because aging populations are adding more retirees than new labourers. And productivity is languishing around the world. Canada’s potential growth rate is now a mere 1.5%. That effectively is the economy’s new speed limit. If the Bank of Canada were to tolerate growth faster than that for too long, it would risk exceeding its inflation target.

These conditions will change behaviour. Corporate profits will decline and rates of return on investment will decrease. Wilkins’s speech was an attempt to coax investors small and large to change their expectations. She spends a lot of her time thinking about financial stability; she knows lower returns could lead to riskier bets—and riskier bets increase the odds of financial crises. And Canadian households aren’t in a great position to absorb a financial crisis. Statistics Canada reported September 15 that the credit-market debt of Canadians exceeded gross domestic product in the second quarter. For now, that debt is being offset by rising asset values, especially housing. But Wilkins said it would be a mistake to assume house prices continue to rise. All things equal, a growing number of retirees would reduce demand for houses, suggesting their value will decline in the future. “There is no guarantee that relying on housing wealth will yield the expected payoff,” she said.

Households at least can take comfort in the fact that central banks are in no rush to raise interest rates. But then that will only force their pension funds to take bigger gambles with their retirement money. Canada’s pension funds have been making increasingly risky bets for several years now. In 2011, Canada Pension Plan Investment Board (CPPIB) took a chance on an obscure Chinese e-commerce outfit called Alibaba. Jack Ma’s company now is one of the world’s biggest retailing concerns. CPPIB’s cumulative $314.5 million (US) in Alibaba has returned more than $1 billion (US).

Snapdeal is no Alibaba. Alibaba is poised to dominate ecommerce in the world’s second biggest economy; Snapdeal is struggling to keep pace in a crowded field. The Teachers’ investment in Snapdeal was akin to going to the races and putting money on one of the outside favourites. Amazon has spent billions in India and now is running neck-and-neck with another local rival, Flipkart, for the title of market leader. Flipkart’s investors have been marking down their investments, dropping the company’s valuation to about $11 billion from $15 billion at the start of the year. Snapdeal also likely is worth less than it was at the height of India’s startup boom last year. The rebranding, “is basically repainting the hull of the Titanic,” investor Mahesh Murthy told Quartz. “It will make the Titanic look better but it will crash anyway.”

It is too soon to say Teachers’ will lose money on Snapdeal. Maybe the red boxes work and the company recovers its footing. Or maybe it ends up being purchased, perhaps even by Alibaba, which also is an investor. That could allow Teachers’ to recover its bet and maybe even make a little money. It’s a brave new world—and until economic growth recovers, there isn’t much of a safety net.


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