Pension Fund Returns Research Articles

Stress testing for IInd pillar life-cycle pension funds using hidden Markov model

AbstractThis paper presents a stress testing technique based on a hidden Markov regime switching model and scenario generations. Firstly, we assume that investor’s risk preferences and beliefs are primarily observed in main world indices and then transmitted to other markets such as IInd pillar life-cycle pension funds. This enables both regime (market state) identification and regime-switching detection. Second, we apply stress to the transition matrix by increasing probabilities of moving to a worse market state, i.e., we increase the transition probabilities on the upper-right side of the main diagonal and decrease the diagonal probabilities correspondingly. Third, future scenarios (evolution) of returns of pension funds are generated using stressed transition matrices and basic risk and performance measures of the final wealth are presented. Finally, three different strategies for pension managers are considered and compared to each other. The results show how the best strategy depends on the stress level.

A Novel Black-Litterman Model with Time-Varying Covariance for Optimal Asset Allocation of Pension Funds

The allocation of pension funds has important theoretical value and practical significance, which improves the level of pension investment income, achieves the maintenance and appreciation of pension funds, and resolves the pension payment risk caused by population aging. The asset allocation of pension funds is a long-term asset allocation problem. Thus, the long-term risk and return of the assets need to be estimated. The covariance matrix is usually adopted to measure the risk of the assets, while calculating the long-term covariance matrix is extremely difficult. Direct calculations suffer from the insufficiency of historical data, and indirect calculations accumulate short-term covariance, which suffers from the dynamic changes of the covariance matrix. Since the returns of main assets are highly autocorrelated, the covariance matrix of main asset returns is time-varying with dramatic dynamic changes, and the errors of indirect calculation cannot be ignored. In this paper, we propose a novel Black–Litterman model with time-varying covariance (TVC-BL) for the optimal asset allocation of pension funds to address the time-varying nature of asset returns and risks. Firstly, the return on assets (ROA) and the covariance of ROA are modeled by VARMA and GARCH, respectively. Secondly, the time-varying covariance estimation of ROA is obtained by introducing an effective transformation of the covariance matrix from short-term to long-term. Finally, the asset allocation decision of pension funds is achieved by the TVC-BL model. The results indicate that the proposed TVC-BL pension asset allocation model outperforms the traditional BL model. When the risk aversion coefficient is 1, 1.5, and 3, the Sharp ratio of pension asset allocation through the TVC-BL pension asset allocation model is 13.0%, 10.5%, and 12.8% higher than that of the traditional BL model. It helps to improve the long-term investment returns of pension funds, realize the preservation and appreciation of pension funds, and resolve the pension payment risks caused by the aging of the population.

A multivariate analysis of SIEFORE daily returns

This document presents a multivariate analysis of the relationship among daily returns of pension funds in Mexico from 1997 to 2019. We provide evidence of a positive relationship among daily returns through five statistical methods. We find Granger causality of the returns of some funds to others, showing that some managers’ decisions affect the others’ investment decisions. We introduce financial-connectedness indicators for daily returns, finding a high degree of linkage and spillovers. The high levels of financial connectedness observed suggest that shocks on the economy affect the SIEFORE returns in the same direction and with generally similar magnitude.

The Power of Financial Incentives versus the Power of Suggestion for Individual Pension: Are Financial Incentives or Automatic Enrollment Policies More Effective?

This study investigates and compares the impacts of two important reforms in retirement savings—matching contribution and automatic enrollment—on participation in the individual pension system (IPS) in Turkey by using a dataset containing information about over 40 million pension contracts for the period of 2004–2021. Unlike the automatic enrollment system (AES), the state matching contribution policy imposes a burden on the state’s budget; understanding the relative effectiveness of the two policies can help protect the public budget from such burdens, especially by taking individual attitudes into account in future policy recommendations. Our estimations indicate that both reforms led to an overall increase in participation. However, the AES is not efficient at encouraging participants to make an active decision on plan characteristics, such as portfolio choices. We also evaluate the effects of the two reforms on IPS participation among different demographic groups. We find that males and married individuals are more responsive to matching contributions, and education levels seem to be closely related with IPS participation. Participants are also sensitive to both the returns of pension funds and alternative investment instruments. All the findings imply that individuals must be encouraged to recognize the need for effective financial preparation in their post-retirement lives. To accomplish this, policymakers could utilize a comprehensive informative campaign and workplace seminars about both the system as a whole and the returns, and they could improve the plan characteristics to be compatible with the needs of individuals before retirement as well as after.

PORTFOLIO AND BENCHMARK RETURNS OF PRIVATE PENSION FUNDS: A COMPARATIVE ANALYSIS FOR TURKEY

The purpose of this study is to ascertain whether pension fund returns are in line with benchmark returns taking into account the regulatory structure in Turkey. The methodology of the study is the cumulative portfolio returns. Data is retrieved from TEFAS Platform and official web site of Capital Market Board of Turkey. Portfolio and benchmark of pension funds are compared. Only standard pension funds are covered within the scope of voluntary pension funds of Turkey. Findings are as follows; Portfolio returns and benchmark returns are in line significantly. The results are partly attributable to the regulations about pension fund management and portfolio structure. The paper also shows that in the long term, the volatility of returns decreases and returns prove to conform with the primary purpose of the private pension system.

Benchmark selection and performance

AbstractUsing regulatory data free of self-reporting bias for 2007–16, we decompose investment returns of 455 Dutch pension funds according to their key investment decisions, i.e., asset allocation, market timing and security selection. In extension to existing papers, we also assess the impact of benchmark selection. Over time, asset allocation explains 39% of the variation of returns, whereas benchmark selection, timing and selection explain 11%, 9% and 16%, respectively. Across pension funds, asset allocation explains on average only 19% of the variation in pension fund returns. Benchmark selection dominates this by explaining 33% of cross-sectional returns. We relate the choice for a specific benchmark to investment, risk and style preferences.

Does it pay to pay performance fees? Empirical evidence from Dutch pension funds

We analyze the relation between investment returns and performance fees for 218 Dutch occupational pension funds with an average total of 1090 billion euro in assets under management from 2012 to 2017. Our dataset is free from self-reporting biases and includes total return, excess return and performance fees for six major asset classes. We find no statistical evidence that the returns of pension funds that pay performance fees to asset managers for active investing are significantly higher or lower than the returns of pension funds that do not pay performance fees. This is true for most asset classes and robust if we correct for risk. We also document that large and more specialized pension funds pay less performance fees for a given level of excess return in alternative asset classes such as hedge funds and private equity. This is possibly the result of better negotiation power due to their larger scale or higher level of expertise.

The Grand Experiment: The State and Municipal Pension Fund Diversification into Alternative Assets

Over a nine-year period (2008–2016), state and municipal pension funds embarked on a grand experiment. They boosted their commitments to alternative assets, spending tens of billions of dollars per year on additional third-party money management fees. The funds’ diversification strategy covered a variety of tactics involving mostly private, but some public, assets. The ostensible purpose of this expenditure was to realize both (i) greater returns and (ii) lower volatilities than those that were produced by the low-cost indexing of publicly-traded investments, which mimicked the funds’ actively-managed asset allocations. This paper compares aggregate public pension fund returns and volatilities, over differing time periods, with a series of institutional benchmarks and replicating indexes. We conclude that the states and municipalities obtained neither lower risk nor higher returns with the higher level of active management and diversification implied by alternative assets. The experiment is thus a failure.

The Determinants and Opportunity Costs of External Management Fees for State‐Administered Pension Plans

Private investment firms receive billions of dollars in fees to actively manage the assets held within state pension funds. We examine the determinants of the fees paid and find that more financially burdensome plans tend to pay more. The magnitude of this relationship declines as the size of the plan increases, suggesting economies of scale. These fees do not appear to be associated with higher pension fund returns. Finally, we calculate the opportunity costs of fees and estimate that most pension funds would be better financially positioned today if they had, instead, passively invested the fees in broad‐based market indices.

Past Performance and Costs of Bulgarian Pension Funds or How Two Pensions Are Less Than One in Bulgaria

The European Insurance and Occupational Pensions Authority (EIOPA) is required to report on costs and past performance of pension vehicles per EU Member state over a trailing 1-, 3-, 7- and 10 years. This paper reports on the costs and past performance of the three major categories of pension funds in Bulgaria per the specifications of the European Commission request to EIOPA. The following conclusions are substantiated: Returns are period-dependent and highly sensitive to the market cycle phase. Pension funds in Bulgaria have produced below market returns on a risk adjusted basis over the 10-year period, ending in 2017. In the more recent 3-year period as well as in 2017, pension funds’ returns have beaten the benchmark. Investors have obtained less than 30% of the pension fund returns in real terms in the past 10 years with the remaining over two thirds of the returns paid in fees and offsetting inflation. This result has improved markedly in more recent shorter periods with real returns accruing to investors accounting to between 42% and 69 % of pension funds’ returns with the remaining 31% to 58 % being paid in fees and offsetting inflation. Two pensions are less than one. Under the current Bulgarian legislation participating in the mass Universal Pension Funds is detrimental to investors as the “supplemental” UPF pension cannot offset the reduction of the state pension, which investors would have been entitled to had they avoided contributions to UPFs altogether. This is due to the fact that past as well as future expected real returns of pension funds’ portfolios cannot yield high enough return in order for the UPF pension to fully replace the reduction in the state pension entitlement.

Benchmark Selection and Performance

Using regulatory data that are free of self-reporting bias for 2007-2016, we decompose investment returns of 455 Dutch pension funds according to their key investment decisions, i.e. asset allocation, market timing and security selection. In extension to existing papers, we also assess the impact of benchmark selection, i.e. the pension funds’ choice for proprietary benchmarks instead of standard benchmarks. Over time, asset allocation explains 39 percent of the variation of pension funds’ returns, whereas benchmark selection, timing and selection explain 11, 9 and 16 percent, respectively. Across pension funds, asset allocation explains on average only 19 percent of the variation in pension fund returns. This is dominated by benchmark selection explaining 33 percent of cross sectional returns. Over time and across pension funds we document that benchmark selection is more important in driving returns than selection and timing.

Does it Pay to Pay Performance Fees? Empirical Evidence from Dutch Pension Funds

We analyze the relation between investment returns and performance fees for 218 Dutch occupational pension funds with an average total of 985 billion euro in assets under management from 2012 to 2015. Our dataset is free from self-reporting biases and includes total return, excess return and performance fees for six major asset classes. We find no statistical evidence that the returns of pension funds that pay performance fees to asset managers for active investing are significantly higher or lower than the returns of pension funds that do not pay performance fees. This is true for most asset classes and robust if we correct for risk and persistence in asset class returns. We also document that large and more specialized pension funds pay less performance fees for a given level of excess return in alternative asset classes such as hedge funds and private equity. This is possibly the result of better negotiation power due to their larger scale or higher level of expertise.

A Long-Term Perspective for Pension FundPortfolios in Chile, Peru, and Mexico

In this article, the authors review pension fund investment returns in Chile, Peru, and Mexico with a long term perspective. They first analyze the historical returns of the private pension systems in these three countries, recorded most of the time only in one type of fund or portfolio. They then run Monte Carlo simulations to gain a glimpse into the future and evaluate potential returns from the new multi-fund schemes adopted by private pension systems, which are intended to allow investing in a number of regulated financial portfolios that vary according to different risk preferences and pension-saver age. The historical analyses finds that the financial crisis had a major effect on private pension funds—these funds experienced sharp drops in returns, particularly those with the highest proportions of equities. These effects were transient, however, and currently the historical returns of pension funds remain at positive levels, making them among the savings alternatives with the best returns in their respective countries. In this regard, private pension funds, with their diversified investment portfolios and provision of liquidity for different markets, companies, and productive projects, have proven to be a significant stabilizing factor for economies. Looking into the future with their simulations, the authors find that the multi-fund scheme has the potential to continue to offer attractive returns on average for pension-savers in the three countries. However, the authors warn that pension levels and replacement rates in the long term do not depend simply on returns, but rather densities of contribution and contribution rates are key factors, particularly for the countries analyzed. Indeed, the densities of contribution and contribution rates are perhaps the most important variables for increasing pension well-being in that they are not random in nature and therefore may be affected by public policies.

An empirical analysis of the performance of pension funds: evidence from UK

Purpose – This paper aims to examine the investment performance of pension funds in the UK using the three standard performance measurement models, the capital asset pricing model (CAPM), Fama-French model and the Carhart model. Design/methodology/approach – The authors use the CAPS-Mellon survey data for the period 1990-2008 and employ the three standard performance measurement models, the CAPM, Fama-French model and the Carhart model in assessing the investment performance of the pension funds. Findings – The authors show that the abnormal returns of pension funds cannot be fully explained by size, book-to-market values, market returns, momentum and the term spread. The authors find larger abnormal returns in bond than in equity portfolios and that smaller funds outperform larger funds. The paper also shows that the addition of the momentum factor does not improve on the three-factor Fama-French model. The authors find that pension funds exhibit superior performance relative to the linear factor models. Research limitations/implications – First, this study contributes to the extant literature on pension funds performance. Future research may also extend the authors' work to incorporate economic, tax, political and legal differences across the countries on the performance of pension funds. Second, due to data constraints, this study excludes the default probability of corporate bonds as an additional variable in their tests on bond returns. Future work may add the default probability as an additional variable whilst examining bond returns. Practical implications – The authors believe that the findings will be considerable food for thought for fund managers who continuously attempt to explore opportunities to provide a higher return to investors. Originality/value – To the authors' knowledge, this is the first comprehensive study that investigates the performance of UK equity and bond pension funds relative to standard linear factor models such as the CAPM, Fama and French, and Carhart.

Rehabilitating the role of active management for pension funds

Pension fund returns can be decomposed into different sources, including market movements, asset allocation policy, and active portfolio management. We use a unique database covering the asset allocations of US defined-benefit pension funds for the period 1990–2008, and we test the role of each factor in explaining their returns. Our results shed new light on pension funds’ sources of performance. While the previous literature emphasized that policy allocation accounts for the bulk of returns, leaving little room for active management, we show that taking explicit account of market movement can change the results significantly. Although active management plays a minor role in global asset allocation, its role is predominant in explaining returns to individual asset classes, whether traditional or alternative. This paper rehabilitates the contribution of active management as a source of performance for pension funds, at least at the asset class level.

Rehabilitating the Role of Active Management for Pension Funds

Pension fund returns can be decomposed into different sources, including market movements, asset allocation policy, and active portfolio management. We use a unique database covering the asset allocations of US defined-benefit pension funds for the period 1990-2008, and we test the role of each factor in explaining their returns. Our results shed new light on pension funds’ sources of performance. While the previous literature emphasized that policy allocation accounts for the bulk of returns, leaving little room for active management, we show that taking explicit account of market movement can change the results significantly. Although active management plays a minor role in global asset allocation, its role is predominant in explaining returns to individual asset classes, whether traditional or alternative. This paper rehabilitates the contribution of active management as a source of performance for pension funds, at least at the asset class level.

Funding of Pensions and Economic Growth: Are They Really Related?

We show empirically that there is no relation between funding of pensions and economic growth in a sample of OECD- as well as non-OECD countries over the period 2001-2008. This finding contradicts findings of earlier studies, which do not control for capital market returns of pension funds. Our estimation procedure consists of two steps: In the first step we explain the change in the pension assets/GDP ratio by capital market returns of pension funds and demographic developments. In the second step we estimate a dynamic growth regression with the residual from the first step-regression as a proxy for funding.

The Value of Guarantees on Pension Fund Returns

Social Security reform has been a serious concern to many countries. In Latin America, a number of reforms have been implemented by partially or fully privatizing pension obligations. Proposals to reform the United States Social Security system have also included privatization feature.(1) Most often, these privatization reforms have encouraged or required that individuals switch from a government-run defined benefit pension plan to a privately run defined contribution system. A potential obstacle exists, however, in gaining political approval for this type of reform. By converting to a defined contribution system, individuals may be exposed to risks not previously faced in a government-sponsored defined benefit plan. Participants in a defined contribution system risk experiencing lower than anticipated investment returns, possibly leaving them with inadequate wealth during their retirement years.(2) To make reforms involving a conversion to a defined contribution system more attractive to the public, governments have typically provided guarantees that reduce individuals' exposure to investment risks. As a result, guarantees of defined contribution pensions have recently become more common, especially in Latin America, which has been at the forefront of pension privatizations.(3) These guarantees differ from the more traditional government guarantees of defined benefit, private pension funds, such as those provided by the United States' Pension Benefit Guaranty Corporation. Defined contribution guarantees have been of two main types. One type insures the periodic rates of return earned by the pension funds in which individuals can invest. Typically, this takes the form of a guarantee that each defined contribution pension fund earns an annual rate of return greater than a pre-specified minimum. The second type of guarantee directly insures each individual's, rather than each pension fund's, return on pension savings. This type of guarantee ensures that participants in a defined contribution system receive a minimum pension payment throughout their retirement years, even if their pension savings are exhausted because of withdrawals during their retirement. Because governments usually retain an insurance obligation following a pension privatization, estimating the value of government guarantees is important for gauging the implicit subsidy associated with a particular pension reform. By accounting for the cost of guarantees in government budget statistics, an improved, market value-based measure of fiscal spending can be obtained. In addition, these cost estimates could make feasible a system of risk-based insurance premiums that would reduce or eliminate the net subsidy from providing guarantees. Previous research on valuing pension guarantees has focused on defined benefit guarantees, with little analysis devoted to guarantees on defined contribution pension plans.(4) But with the growing popularity of defined contribution pensions and their critical role in many recent pension reforms, research analyzing defined contribution guarantees is clearly needed. This article derives a number of new results for valuing these guarantees using analysis. It illustrates that the martingale pricing technique for calculating contingent claims values can be a unifying framework for valuing many kinds of guarantees. This technique may yield explicit formulas for guarantee values, or it can allow for numeric valuation by Monte Carlo simulation. Defined contribution pension guarantees bear some similarities to guarantees made by insurance companies on the minimum maturity cash value of equity-linked life insurance policies. Research on such insurance policy guarantees includes Brennan and Schwartz (1976), Boyle and Schwartz (1977), and Banicello and Ortu (1993). However, guarantees on a pension fund's periodic rates of return differ, because they are a series of sequential guarantees, not a single guarantee based on a maturity value. …