Global crisis: pension fund management and returns

Standard portfolio theory argues that diversification leads to the minimization of idiosyncratic risks (i.e. the risk of any individual asset), although it can no diminish the aggregate risk. This crisis highlights that this statement is correct for pension funds, as can be seen in the next graph, the countries that show the highest diversification of the pension funds are also the countries that show the worst returns. This is explained because diversification in pension funds many times means the possibility of investment in riskier assets, such as equity for example (see second graph), assets that have had worst returns that government bonds.




Although the worst performance of the equity compared to bonds in this crisis, we should keep in mind that in general in the long term equity has had higher returns than fixed income instruments.
This take us to another issue that we commented in a previous note, which is how to manage national social security agencies reserves to minimize the financial and political risks. At the CISS we have analyzed the management of pension funds. We have concluded that a very interesting case is the one in Canada. In Canada, it is an external entity that manages the reserves of pension systems. This situation has allowed them to establish more flexible investment regimes and has minimized the risk that the reserves are used for a different purpose than to pay future pensions.
Surveillance institutions, pension fund managers and national social security agencies can take advantage of current situation to advance new policies regarding the management of pension funds. The CISS jointly with the ISSA and OISS are organizing a high level meeting to analyze recent experiences in reformed systems. The meeting will be held the next 9 and 10 of December in Santiago.