News | Wednesday, 06 January 2010

The recovery of funded pensions

Clyde Caruana

In anticipation of future inadequate pay-as-you-go pension plans, various governments have legislated in favour of funded pensions (be it public or private pensions) in order to counter-balance the shortfall in income of upcoming retirees. Although the concept is not new, few are those countries with mature pension asset holdings. The OECD definition of a ‘mature’ pension fund market is accredited to countries where assets-to-GDP ratios exceed the 20 per cent ceiling. As at the end of 2007, only eleven out of the thirty OECD members attained such a ratio: Iceland, Netherlands, Switzerland, Australia, United Kingdom, United States, Finland, Canada, Ireland, Denmark and Japan.
In 2007 the market value of pension assets withheld in funds was worth a staggering $27.8 trillion, equivalent to 75 per cent of the OECD weighted GDP. The stock market crash of 2008, followed by the recession, battered heavily on such funds as some $5.4 trillion worth of assets were wiped out. The OECD estimates that pension funds in 2008 recorded an average negative nominal return of 21.4 per cent. The hardest hit were countries with high portfolio exposure to equities such as Ireland (-35 per cent) and the United States (-24 per cent), where the respective investment share in equities was 66 and 57 per cent.
Following the stabilisation of markets and some recovery from rock-bottom share prices, up to the end of June 2009 pension funds successfully managed to recoup part of their losses by registering a positive return of 3.5 per cent. In monetary terms this translates into the equivalent of $1.5 trillion or slightly less than a third of the value lost during the preceding year. Norway and Turkey were the highest performers during the first six months last year as their pension funds recorded a nominal return higher than 10 per cent. Not incidentally, both countries have high shares of their investment in bills and bonds.
Over the past months, fund managers and country legislators have learnt the hard way that the best approach of earning a decent return is through diversification, both in instruments and markets. Nonetheless, the risk responsiveness of savers has changed considerably as in countries where contributors are offered the option to decide upon asset allocation are heavily tilting the balance on safer bets such as bonds. As a result of the equities downfall, the OECD estimates that asset allocation in equities within two years dropped by 9 percentage points to 41 per cent by December 2009. The drawback that may arise from such circumstances is that whilst capital may be more secure, the rate of return earned decreases considerably, thus leading to smaller pension pots in the future.
Despite the havoc created by the credit crunch, it presents ample opportunities to learn from. As economies start to recover and regenerate income, people will again divert more savings into their retirement accounts. The increasing pension markets will bear more weight of tomorrows’ wealth holdings, hence the need for global regulation which governs pension funds is pressing more than ever before. Funded pensions can still be considered to be one of the potential solutions in lessening the impact of ageing. Notwithstanding occasional dips, a long-term outlook assessment over the past fifteen years suggests positive nominal returns for pension funds in Sweden and the United States (to name a few) with 7.2 and 6.9 per cent respectively.

Clyde Caruana is a statistician at the National Statistics Office



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06 January 2010


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