The creation and destruction of capital

Abstract

The investment management community faces a daunting challenge to provide the pensions sector with the desired rate of return, given that the recent financial crisis resulted in such an extensive destruction of capital. The current outlook for profits remains uncertain due to the massive amount of debt outstanding in developed markets. Moreover, the outlook for bond returns is also clouded due to the impact of interest rates having to rise at some stage, which will result in falling bond prices. Although the sector cannot beat the market overall, it can change the way it thinks about the benchmarking of returns through time by reducing the volatility of returns and investing through the business cycle. This can be achieved by analysing the Wicksellian Differential of an economy which as Chapter 6 demonstrated is closely linked to the rate of profit and therefore the performance of equities. Hence such an approach could be used in an investment process to trigger asset allocation decisions between equities and bonds providing pension funds with more stable returns through time to help match their liabilities. Given that monetary policy was unable to identify one of the largest credit bubbles in the history of financial markets, there is no reason why the signals emanating from central banks today are likely to be of much use in preventing capital destruction in the future.

A capitalist economy is not and cannot be stationary. Nor is it merely expanding in a steady manner…Economic progress in a capitalist society means turmoil.

Joseph Schumpeter¹