Strategy Update: July 2025
How Pension Fund Investment Behavior Drives Global Stock Markets and Resembles the Former Soviet Union
REVIEW
THE FINANCIAL MARKETS IN JUNE
June was characterized by geopolitical tensions and uncertainties that led to volatility in financial markets. Following Israeli airstrikes on Iranian nuclear facilities in mid-June, an escalation threatened. The US was also militarily involved. Fear of a regional war temporarily drove oil prices up to around USD 78 per barrel and led to increased demand for gold and government bonds. Gold temporarily reached a new all-time high of nearly USD 3,450 per ounce. A ceasefire mediated by Washington brought temporary relief. Despite its fragility, it was sufficient to push oil prices back to mid-June levels – before the Iran-Israel conflict – and give new momentum to global stock markets. US Federal Reserve Chair Jerome Powell continued to stand up to President Trump and left the federal funds rate unchanged in the range of 4.25–4.50 percent – despite all objections from Trump, who had repeatedly demanded a rapid reduction in borrowing costs. This marks the fourth consecutive time that monetary policymakers have resisted the US President‘s demands. Furthermore, the central bankers expect a higher inflation rate of 3.0 percent this year (previously 2.7 percent) and lowered their growth forecast from 1.7 to 1.4 percent – an indication of rising stagflation risks. Toward the end of the month, Powell buoyed markets. Before the US Congress, he emphasized that given the uncertain economic outlook, faster interest rate cuts were also conceivable – should inflation or the labor market deteriorate. Investors reacted positively and now expect at least two rate cuts by year-end.
The Swiss National Bank lowered the policy rate to 0 percent – in response to the strong franc and negative inflation. The franc has appreciated significantly over the course of the year, which lowers import prices and pushes inflation below the SNB‘s target range. President Martin Schlegel did not rule out further rate steps below zero but emphasized that this was not the base scenario. Stock markets recovered significantly toward monthend. US technology stocks benefited from interest rate hopes, and the technology index Nasdaq 100 reached a new record high, while European exchanges remained more subdued – burdened by weak economic data and possible new US tariffs. The NATO summit in The Hague brought agreement on a new defense target of up to 5 percent of GDP by 2035. Defense companies benefited once again – the sector remains structurally in demand. In times of growing uncertainties and geopolitical upheaval, security themes are gaining importance among investors – this is reflected in some cases by high valuations. June was thus a month of ups and downs. While the conflict between Israel and Iran temporarily caused strong market movements, a fragile ceasefire and more moderate statements from the US Federal Reserve toward month-end led to a recovery – particularly in stock markets. The question remains whether this phase of relaxation will persist or whether new stress factors, such as the threatened end of the US tariff pause in July, already represent the next test for markets and politics.
OUTLOOK
NO STRUCTURAL BREAK IN US TREASURY BONDS VISIBLE (YET)
With the expiration of the US tariff pause on July 9, a turning point in the global economic order is approaching. The probability that President Trump will impose new import tariffs – especially on European goods – is high. Following the precedent with Great Britain, many observers consider an effective US tariff rate of 15 to 18 percent realistic. This would cause trade integration to fall back to 1940s levels – with consequences for inflation, growth, and geopolitical stability. After the IMF already massively cut US growth forecasts for the next 2 years, the OECD has now followed suit. The OECD expects US growth of just 1.6% and 1.5% for 2025 and 2026, respectively. This raises the question of who will be able to replace the US as the global growth engine. In terms of size alone, only a few countries qualify. China continues to process the consequences of its domestic real estate crisis, and while Europe is growing more strongly – also thanks to investment programs – this is still at a low level. Not only do measures against looming tariffs increase inflationary pressure, but housing costs in the US are also rising slightly again. In the American inflation basket, prices related to rent (Shelter) account for by far the highest weight – 36%. Thus, „Shelter“ contributes 1.4% to total inflation of 2.35% – by far the highest share, followed by „food away from home“ at 0.21%. Housing costs are measured very opaquely and lag almost 1 year behind actual housing costs – currently, rents in the US are supposed to increase by 4% p.a.
An indicator that measures rental price changes in real time is the Zillow Index (a counterpart to Homegate); this suggests a rental price increase of 3.1%. Thus, it will still take a long time before the main driver of inflation (housing costs) lies within the central bankers‘ inflation target band. Rising inflationary pressure coupled with declining growth and increasing government debt represents a toxic mix for a state in the long term – even for „the greatest country.“ This risk is currently only visible in American bond markets. The 30-year US rates, to which almost all American mortgages are pegged, stand at 4.8%. Such high interest rates were last seen in 2023 or 2007. A detailed analysis of US Treasury auctions over the past 20 years refutes claims about a structural collapse of the US government bond market. While the Federal Reserve‘s (SOMA) share of auctions has risen to 5.2% ($167.2 billion), it remains well below the 2022 peaks of over 13.5%. The reasons for the recent increase are multifaceted: Fed QT reinvestments, unusually high government bond issuances, and targeted market stabilization measures through SOMA reinvestments. The analysis shows that market movements cannot be attributed exclusively to political factors or declining foreign interest. Rather, a sound assessment requires consideration of the complex interactions between Fed policy, supply and demand dynamics, and macroeconomic factors.
FOCUS
HOW PENSION FUND INVESTMENT BEHAVIOR DRIVES GLOBAL STOCK MARKETS AND RESEMBLES THE FORMER SOVIET UNION
PENSION ASSETS
Pension funds play a crucial role as drivers of global financial markets. Particularly through retirement plans, they account for a significant portion of inflows and outflows into passive investments. The Global Pension Assets Study estimates the global assets of pension funds in the largest 22 markets (P22) at $58.5 trillion. The US is the largest market, accounting for 64.9% of P22 assets. Japan and the UK follow; together with the US, these 3 countries are responsible for 82% of pension assets. Switzerland ranks at a remarkable 7th place with estimated pension assets of $1.4 trillion.
ASSET ALLOCATION
The asset allocation of global pension funds has changed over time. While allocation to stocks and bonds has declined, investments in alternative assets have increased, albeit at low levels. US and Australian pension funds show higher equity allocations than others; on average, equity allocation is around 50%. Notably: In Japan, the equity allocation is just 27% and the bond allocation is 55%, even though interest rates in Japan are below 1% – meaning investment returns will hardly be able to secure the purchasing power of beneficiaries in the long term.
According to the study, Switzerland has an equity allocation of 32%, a bond allocation of 30%, and a very high proportion of real estate investments on average. Back to the thesis that investment behavior drives equity markets. The share of investments in domestic stocks among the largest 7 regions has continuously declined over the past 25 years – with one exception. US pension assets have increasingly been invested in US stocks again over the past 10 years. The US shows by far the highest value with a share of almost 69% in domestic stocks. Japan, on the other hand, invested around 70% of its equity allocation in domestic companies 25 years ago; today it is less than 25%. This is a significant driver behind the US market dominance, which now accounts for more than 65% of global equity market capitalization.
PASSIVE INVESTING
Many pension funds do not have a long-term investment horizon; rather, investment returns are measured annually against a benchmark index and reallocations are made based on this. This results in managers taking fewer risks and pension assets being invested increasingly similar to market capitalization – to reduce their career risk. This leads to steady demand for passive investment solutions. Passive investing has evolved from a niche strategy to a dominant force and is reshaping financial markets in unprecedented ways. Index funds and Exchange Traded Funds (ETFs) have experienced enormous growth in recent years and now manage a significant portion of global investment assets. The growth of passive investing, driven by institutional investors such as pension funds, leads to increased market concentration, altered liquidity, and new challenges for active management, but also harbors systemic risks.
IMPACTS
The growth of passive investing is undeniable. In 2024 alone, passive investments recorded global net inflows of around $1.1 trillion. In the US, passive investments now account for almost 50% of managed fund assets. The reasons for this growth are manifold: low costs, broad diversification, and the fact that many active managers disappointed and could not beat their benchmark indices in recent years. However, passive investing is also changing the structure of financial markets. Since index funds buy stocks in proportion to their market capitalization, this leads to increased market concentration. The seven largest stocks now account for more than 30% of the S&P 500. At the same time, passive flows reduce price elasticity, which can lead to exaggerations and bubbles. Passive flows are often inelastic, where price and thus valuation play no role.
Liquidity is also changing and concentrating on a few capital-strong companies. Morten Springborg of WorldWide Asset Management emphasizes that the allocation of capital based on market capitalization rather than risk-adjusted return expectations comes dangerously close to the operating system of the former Soviet Union, where capital was allocated to the largest (employers) to support the stability of the system, and not to make the system grow.
CHALLENGES
These developments present investors with new challenges. Market narrowing makes it more difficult for them to achieve outperformance against benchmark indices, as their portfolios are less likely to contain all the few winning stocks. At the same time, the rise of passive investing leads to an increase in the average skills of active fund managers, as underperforming managers increasingly struggle with outflows and eventually disappear from the scene. Furthermore, passive investing also harbors systemic risks. It can increase markets‘ vulnerability to shocks. There is a danger of „Self-Inflated Returns“ and Ponzilike dynamics when flows chase past performance. A study by Philippe van der Beck, Jean-Philippe Bouchaud and Dario Villamaina titled „Ponzi Funds“ from 2024 examined the effects of large inflows into active ETFs. The study focused on an active ETF that was anonymized but easily identifiable as the ARK Innovation ETF. The study decomposed realized fund returns into price pressure and fundamental components and showed that it was impossible to distinguish between management skills and price pressure. Or put differently: The ETF buys those stocks whose prices, driven by passive inflows, have risen the most and thereby causes prices to rise ever further – „Self-Inflated Returns“.
CONCLUSION
Passive investing has profound and complex impacts on financial markets. It leads to increased market concentration, altered liquidity, and new challenges for investors. Pension funds play a key role in this development, as they account for a significant portion of inflows into passive investments. Investors should be aware of the opportunities and risks associated with passive investing. Steady inflows into passive investments by pension funds drive up valuations of stocks with the largest index weights, while outflows put pressure on non-benchmark stocks. Demographic changes, such as the baby boomer generation beginning „dissaving,“ could impact equity markets as they reduce their investments.
New trends and challenges for pension funds are emerging. The influence of politics and governments is increasing, e.g., through incentives for domestic investments or net-zero commitments. The inflows and outflows of pension assets are driven by the labor market. Someone who has a job pays capital into their retirement savings in many countries automatically (through the employer) or voluntarily (through the employee) – also due to tax privileges.
This „fresh“ capital is invested on average 50% in stocks and to the absolutely largest extent in American companies. But what if the labor market suddenly weakens and this „fresh“ capital disappears? The biggest beneficiaries will be most affected in the short term by the marginal decrease in „fresh“ capital. Those companies whose prices were driven up most by the effect of „Self-Inflated Returns“ are then exposed to the highest selling pressure. The market concentration of these companies can now represent a systemic risk – short and rapid market dislocations are a consequence. Similar to the former Soviet Union, this behavior supports the current system; but what if new disruptive technologies challenge the market power of current leaders? Moreover, this can create false capital allocations or wrong incentives that weaken the real economy in the long term. Google would be non-existent without data centers, data centers don‘t exist without semiconductor chips, semiconductor chips don‘t exist without raw materials, raw materials don‘t exist without machines, etc. Currently, however, only a few companies in this supply chain are allocated „fresh“ capital.
Since the investment behavior of pension funds does not change or changes only very slowly, an early end to passive growth is not in sight. As a result, market shares and market concentrations will not change significantly overnight. An investor who bets against the US or against large companies or does not hold them in their portfolio is exposed to headwinds from the investment behavior of pension funds and the associated trend of passive investing.
The golden middle path between passive investments in markets where this makes sense, supplemented by risk-adjusted investments in niche investments and diversifying asset classes, appears most promising in the long term.