Monday 22 February 2021

In case you missed it - Pension Funds and Drivers of Heterogeneous Investment Strategies

Prize Winners

For those who were unable to attend, we compiled the key takeaways of the webinar featuring Dr. Kristy Jansen, of Tilburg University and De Nederlandsche Bank.  

Defined benefit pension plans are very important, from a global perspective. This is because around 50% of retirement savings are in DB plans, explains Kristy Jansen. "And the returns that the funds generate can have a huge impact on a retirement income. A 100 bps lower return over an accrual period will result in a reduction in retirement income by about 25% meaning you have to increase contributions by 1/3 to maintain income."

The exit barriers for beneficiaries to leave pension funds are high with defined benefit plans – you can typically only change funds by changing jobs. There is also no freedom of choice about the investment decisions being made on behalf of the beneficiary.

"Interestingly, we know very little about how pension funds make their investment decisions," says Jansen. "This is due to a lack of detailed data about the funds. We are trying to discover what determines the investment strategy of pension funds."

Jansen and co-author Dirk Broeders set out to discover what drives homogeneity across pension funds. "Within one regulatory jurisdiction, how can we explain how pension funds do things differently? We measure this by looking at the funds’ factor exposures within equity and fixed income portfolios. We explain the homogeneity in context by looking at two main drivers derived from a model of mean variance preferences of asset liabilities. We show that according to the model, characteristics such as the funding ratio, risk aversion and liability duration affect investment strategies and explain why strategies differ. From that model we also derived the remainder of the differences in the investment strategies – also called differences in investment beliefs. We also examine the role of an asset management firm."

Primary findings

"There is large heterogeneity in investments across pension funds," says Jansen. "Pension fund characteristics – funding ratio, risk aversion, and liability - explain only about 36% of this heterogeneity.  The remaining heterogeneity reflects a difference in average annual returns of about 0.70-1.50 percentage points, which is equivalent to an average retirement income of 16-32%. This is attributed to a difference in investment beliefs, and is partially revealed by the choice of the asset management firm."  

In terms of policy implications, Jansen recommends disclosing and explaining investment beliefs in a clearer and transparent way to beneficiaries and other stakeholders.

View the webinar via: