Globally pension funds showing strong growth post credit crisis

Having weathered the financial crisis, pension fund asset levels in most countries continue to show strong growth and are on the way to returning to pre-crisis levels, according to a new report from the Organisation for Economic Co-operation and Development.

During 2010, both economic and financial indicators showed signs of further recovery. However, the outlook for future economic growth in developed economies remains uncertain and sluggish, it says.
 
A sustained period of low long term interest rates is an important medium term risk for pension funds, which typically have long term obligations to pension members, according to the author of the report, André Laboul, head of the Financial Affairs Division.

‘These future obligations become more expensive in today’s terms when low interest rates increase the value of their liabilities. Their financial position worsens, even though an increase in the value of invested assets may mitigate this effect,’ he explained.
 
‘Against this backdrop, pension funds face other challenges and risks, such as recent accounting and regulatory changes. While bringing further transparency, the adoption of the new rules within IAS19 over the coming years which eliminate the smoothing option will increase volatility in sponsoring companies financial statements.

‘As a result, there will be added pressure to reduce risk in pension funds’ asset holding in order to mitigate volatility and to keep funding ratios more stable than in the past. Pension funds may also transfer risk to financial markets via insurance or by greater use of derivatives for hedging purposes,’ he added.

The report points out that the trend away from pure, defined benefit plans, DB schemes, which guarantee a certain replacement rate and specify pension benefits according to the employee’s final pay, length of service and other factors, towards defined contribution arrangements is also likely to intensify.
 
Regulatory changes are most likely in the European Union, as a result of the review of the pension funds directive (known as Institutions for Occupational Retirement Provision).The review includes a new look at funding and solvency regulations.
 
Some other OECD countries have already reformed their funding rules. Canada stands out by having introduced a mechanism to ensure a high degree of counter cyclicality by raising funding requirements in good times and allowing relatively long recovery periods.
 
Overall pension funds experienced on average a positive net return on investment of 2.7% in real terms, 4.3% in nominal terms, in 2010. The best performing pension funds amongst OECD countries were in New Zealand at 10.3%, Chile 10%, Finland 8.9%, Canada 8.5% and Poland 7.7%.

On the other hand, in countries like Portugal and Greece, pension funds experienced, on average, a negative rate of investment returns, down 8.1% and 7.4% respectively.

Until December 2010, pension funds in OECD countries had recovered US$3 trillion from the US$3.4 trillion in market value that they lost in 2008.
 
The report also shows that pension fund assets in most OECD countries, in local currency terms, have climbed back above the level managed at the end of 2007. Some countries however have not recovered completely from the 2008 losses. This was the case for Belgium whose assets at the end of 2010 were 10% below the December 2007 level, Ireland 13% below, Japan 8% below, Portugal 12% below, Spain 3% below and the United States, also 3% below.
 
In most of the OECD countries for which was received data, bonds, not equity, remain by far the dominant asset class, accounting for 50% of total assets on average, suggesting an overall conservative stance. Countries like the United States, Australia, Finland and Chile showed significant portfolio allocations to equities, in the range of 40% to 50%.

In Austria, Finland, Poland and the Netherlands, the weight of equities in portfolios increased substantially from 2009 to 2010 in the range of 6 to 7%, while bond allocation fell by a similar amount.

Public pension reserve funds (PPRFs) continued their steady growth throughout 2010. By the end of the year, the total amount of PPRF assets within OECD countries was equivalent to US$4.8 trillion, compared to US$4.6 trillion in 2009. The average growth rate compared to 2009 was 5% and the average asset to GDP ratio in 2010 was 19.6%.
 
Although most PPRFs performed positively in 2010, investment returns were lower than in 2009. PPRFs in countries who submitted data continued to regain the ground lost during the 2008 financial crisis, with positive investment returns over the 2008/2010 period reaching 2.6 in real terms, 4.4% in nominal terms, on average. The funds with conservative investment portfolios are still ahead in terms of performance for that period.