How does my pension fund invest my money? More and more people around the world are asking this question. As the global population ages, it has becoming increasingly important to ensure that pension funds are efficiently and effectively managed so they can deliver a secure income in retirement.
At the same time, countries require more investment in productive areas such as infrastructure, housing and new businesses to continue to grow.
Globally, pension funds have some US$38 trillion in assets under management; the world’s 300 largest pension funds manage around $16 trillion. This ranges from the Government Pension Investment Fund (GPIF) in Japan -- the largest pension fund in the world with $1.3 trillion in assets -- to funds such as the Government Institutions Pension Fund (GIPF) in Namibia which, though smaller in absolute terms (owning $7 billion), constitutes almost 70% of domestic Namibian GDP.
It might sound improbable to hear a CFO say this, but I consider one of my roles since joining the World Bank Group to be that of matchmaker. Let me explain.
As I have noted in other blogs over recent months, the world’s emerging market and developing economies—EMDEs for short—face an enormous gap in infrastructure investment. Certainly it is not the only big financing challenge that countries face as they work to reduce poverty and extend prosperity to more of their citizens. But infrastructure underpins many aspects of economic growth, getting people to jobs and schools, connecting goods to markets, reducing the isolation of the poorest areas in many countries. And by some estimates, the sector’s funding gap is as high as a trillion dollars.
In August this year, the Government of India approved the recommendations made by the Sub-Group of Chief Ministers on Rationalisation of Centrally Sponsored Schemes (CSS). The rationalisation plan would first prune the existing 66 CSSs to 28, and then further divide them into three categories – six ‘core of the core’ schemes, 20 core schemes, and two optional schemes. The ‘core of the core’ schemes include the pension schemes, MNREGA, and four umbrella schemes targeting “vulnerable sections” of the population. Further, the flexi-funds component of the CSSs would be increased to 25% for the state governments to programme. Another set of recommendations were made around the modalities of release of funds. For instance, the release of a tranche of funds would no longer be dependent on producing an Utilisation Certificate of the previous instalment; and instead, it would be based on the submission of the instalment preceding the last one.
This is another step in the process of improving the governance of CSS in India, with the specific rationalisation exercise being prompted by the ongoing fiscal reorganisation between the centre and state governments. Starting last year, transfers from the centre to state governments went up by approximately INR 1.8 lakh crores. This was a result of the 14th Finance Commission recommendations which increased the devolution of the centre’s tax receipts to state governments from the prevailing 32% up to 42%. This reduced the ability of the central government to continue funding CSSs at their previous levels, and at the same time, provided state governments a greater measure of flexibility in financing its own priority development schemes.
The investment of pension fund assets has moved from an obscure topic for actuaries, to an issue which raises political attention at the highest level.
This is for the simple reason that it directly touches the social and economic livelihoods of people.
Since the 2008 global financial crisis, developed economies have been looking for additional sources of long-term capital to fill the gaps which bank and government balance sheets can’t fill. This is a search that has engulfed the developing world for much longer if not for as long as they exist. Younger developing economies are starting to see their pension funds grow, side by side with an increasing awareness of the impact which productively invested assets can have on economic growth both today and tomorrow. If invested for the aligned intensions of social impact and financial return, pension funds can improve people’s lives today and secure their income in future. However, this isn’t a general phenomenon – applying only to larger funds which have invested in the intellectual capacity of their Trustees, and in countries which have understood and embraced the strong relationship between the macroeconomic performance and asset performance.
Redirecting pension investments from short-term assets (government paper, bank deposits) to investments with a long-term impact is key to delivering, not only improved, but sustained returns. Private equity (PE) - equity capital not quoted on a public exchange – is one such asset class. PE investment is increasingly in vogue as such capital is the foundation of all economies, and indeed leads to the development of robust stock markets. If structured with pension investors’ risk-return consideration in mind, it can deliver the diversification benefits which these investors need. If properly targeted, such investments will be vital in meeting the Sustainable Development Goals, considering that 15 of the 17 SDGs have a focus on growth, development and sustainability (the last two being on implementation and capital resource origination). Active participation in investee companies by shareholders such as pension funds will be vital for ensuring a future sustainable and shared economy. In turn, for this to work optimally, requires conscientious and capable Trustees.
Did you know that in Kenya less than 15% of the population is covered with old age security? This means that many Kenyans are facing a vulnerability of retiring into poverty. But this is not accidental since established factors identified in studies commissioned by Retirement Benefits Authority (RBA) necessitate this situation.
However, Kenya is starting to tackle some of these factors and to help increase pensions coverage to reach more Kenyans to help reverse the state of affairs.
1. A chief factor limiting pension growth is that the formal sector is creating fewer jobs. Despite the positive economic growth registered in the country, employment growth in the formal sector is slow. For example, only 128,000 out of the 841,600 new jobs created in 2015 were formal. This has a direct effect on the pension services since the structure of the industry is still highly biased towards the formal employment model.
Transactions that facilitate employers and employees to contribute are generally conducted from the pay slip, and formal employers adhere more to the regulations and legislation on the issue compared to those who operate informally. As a result, millions of citizens have been cut off from the pension system.
Luckily, this gap is slowly being narrowed by Individual Pension schemes that are specifically targeting the informal sector workers. An example of this is the Mbao pension scheme. The Plan is an inventive idea that adapts a savings product to marginal population groups and contributes to their improved social and economic security.
While many of us work hard to postpone growing old, ageing populations as a whole are inevitable, predictable and something countries can prepare for.
As developing countries prosper, their citizens will live longer and, hopefully, healthier lives. By 2050, the number of people in the world 65 and older will have doubled from 10% to 20%. By then .
Are these countries set up to care for these forthcoming senior citizens and ensure they have the resources to live in dignity in old age? Will countries be able to ensure fairness between the generations and resources?
Current pensions systems leave many pockets of society uncovered:
- As countries become more urbanized and families have fewer children, traditional family-based care for the elderly is breaking down, without adequate formal mechanisms to replace it.
- Traditional employment-based pensions systems don’t cover most informal sector workers in developing economies. In some regions, these workers account for two-thirds or more of the working age population. Even for those with formal sector jobs, pension coverage has been declining for people who’ve entered the workforce since 1990 in terms of years contributed over lifetime, according to World Bank Pensions Database. This has a major impact on the amount of retirement income they will eligible to receive.
At the start of the decade, the World Pensions Council (WPC) and the Organisation for Economic Co-operation and Development (OECD) helped convene some of the first international summits focusing on the future of long-term investments in the post-Lehman era, arguing that infrastructure would soon become an asset class in its own right.
At that time, we thought that the crisis would usher an era of durably low interest rates, pushing more pension and insurance investors to pursue a “quest for yields,” increasing mechanically their allocation to non-traditional asset classes such as:
Imagine yourself on a comfy seat like the ones they give to ministers. But do not get too cozy as you are about to make a difficult decision. Population is aging in your country, and there simply is not enough resources to finance the pension benefits of the retirees. What should you do?
The conventional wisdom suggests that you should increase the retirement age. The argument goes as follows. People live six years longer in retirement now than half a century ago. Therefore, using some of those additional years for work is not completely unfair. By increasing the retirement age, you could increase the number of contributors while decreasing that of beneficiaries at the same time. This should provide an effective remedy for the imbalances in pension system accounts.
Investing in people starts by ensuring that graduates leave school with strong basic/foundational skills, such as in reading and mathematics. Such skills are critical for subsequent study, for quickly finding a first job, and for adapting to continuous technological change. But are countries in the EU ready to face that challenge?