Investment constrains for pension funds.pdf

University of St. Gallen

Master of Arts in Banking and Finance

Do quantitative investment constrains lower

long-term term pension fund performance?

__________________________________________________________________________________________

Research Seminar Pension Finance

Authors:

Alain Kunz

[email protected]

05-608-542

Mauro Baertsch

[email protected]

05-607-494

Referee:

Prof. Dr. oec., Dipl.phys. ETH Hans-Jürgen Wolter

University of St. Gallen

6 May 2011

Introduction

2

1 Introduction

The paper examines the quantitative investment constrains for pension funds in Denmark,

Netherlands, Sweden and Switzerland and delivers a comprehensive study on the long term

investment performance of each system. The paper examines the question whereby

quantitative investment constrains have a significant impact on the allocation of the

investment portfolio and how are the long-term investment results affected by the given

quantitative investments constrains.

The four countries are comparable to each other due to similar building blogs of the pension

fund system, similar life standard, national income per capita, welfare state and according to

Melbourne Mercer Global Pension Index three systems are state-of-the-art pension systems.

The Melbourne Mercer Global Index examines the pension system on the principles of

adequacy, sustainability and integrity, whereby the Netherlands accomplished the highest

score of 78.9 of 100 points, followed by Switzerland, Sweden (Mercer, 2010), however the

system of Denmark is not included in the survey.

All four systems are equally structured and contain a so-called three-pillar system. The three

pillars are differently financed and provide a direct, intertemporal or individualized transfer of

wealth. The first pillar guarantees a decent minimum income for all citizens independent from

their personal wealth or status of employment. The second pillar consists of supplementary

pensions which are built up as part of people's terms of employment. The primary

responsibility for these pensions therefore lies with employers and employees and it ensures a

certain level of financial freedom depending on the accumulated wealth during the working

period. The third pillar consists of supplementary personal pensions based on individual

private savings.

The key macroeconomic and welfare issue arise from the choice of financing the system. In

general two ways of financing exists. The so-called pay-as-you-go (PAYG) system suggests a

direct transfer of wealth from workers to pensioners. The PAYG system has the advantage of

offering immediate pensions, without waiting for assets to accumulate and moreover remove

the inflation risk to pensioners. Davis (1993) points out, that the PAYG "can provide a higher

rate of return to each generation, if the sum of wages and employment growth exceed the

interest rate. However if they do not, then there may be a corresponding fall in rates of return

and increase in costs per capita". Another disadvantage arise from the fact that workers and

Introduction

3

employers bear an increasing burden of social security contributions and affect the

competitiveness of a country in a negative way. The other way to finance the system is by

funding or in other words by accumulating of wealth within a pension fund system or on an

individual basis. Davis (1993) suggests countries to use a mixture of both (Davis, 1993). The

table 1 below deliver a summary of the above information.

Table 1: Overview of the Multi-Pillar pension system

Pillar I Pillar II Pillar III

Financing Taxes / PAYG Contribution from employer

and employee

(fully-funded)

Contribution from employee

(fully-funded)

Contributions Taxes / PAYG Fixed amount Individual

Benefits Minimum amount, life

long

Accumulated assets, life

long

Individual assets, depending

on the accumulated amount

Members Citizens of a country or

residents over a certain

time

Wage earners, over a certain

minimum income or hours

per week

Wage earners and self-

employed

Source: Mercer (2010)

The paper discuss delivers a survey of the different regulatory investments constraints and

examines the direct impact on the portfolio. First of all we discuss the quantitative investment

constrains, later the portfolio allocation is analysed and in a later part the real investment

returns are considerate. In general the pension and other institutional assets manager display a

strong "home bias". The paper examines if the lack of foreign diversification is greater in

countries with more prudent investment constrains and how are the portfolio in a general

structure allocated.

According to Reisen (1997) a pension fund does not only seek to maximise return. The

pension fund also concentrated on the real purchasing power of their assets. In fact, due to

currency fluctuations long term deviations from purchasing power parity (PPP) existed.

The paper analysis only the quantitative investment constrains in the second pillar of the

pension fund system. Pillar I is organised according to the PAYG and assets are directly

transferred from workers to pensioners without an investment process. Pillar III is highly

individual and a comprehensive study of the investment returns across different pension

system nearly impossible. Pillar II on the other hand is in all analysed countries nearly similar

organised and surrounded by a given law system.

Introduction

4

The article is structured as follows: In Section 2, we review the previous research on the

investment constrains of the pension systems of Denmark, Netherlands, Sweden and

Switzerland. Section 3 provides a comprehensive overview of the investment constrains in

each pension system and provides an overview of the recent changes in the investment

constrains. Section 3 furthermore provides a description of the asset allocation in each

pensions system and Section 4 characterizes our data set problem. In Section 5 we conclude

the results.

Literature

5

2 Literature

So far, relatively little research has been done on the investment constraints of international

pension funds and the impact of the regulation on the overall real investment performance.

The European Commission (1999) published a comprehensive study on international pension

system and pointed a negative correlation between asset restrictions and investment returns.

Alier and Vittas (2000) examine that in several European countries, including Germany,

Netherlands, and Switzerland, government regulation impose quantitative limits on

investment allocations with the goal to reduce volatility and even though employers operate in

most cases with defined-benefit plans and absorb the investment risk. They concluded that

a less volatile pension portfolio would normally imply a lower return and therefore lower

replacement rate and pension. The opportunity cost of lowering portfolio volatility can be

quite significant in case of a high equity premium.

Queisser and Vittas (2000) examine the Swiss Multi-Pillar pension system closely and their

analysis of the investment policies shows that Swiss pension funds used to be extremely

conservative. The funds did not reach the investment constraints limits of any category of

investments. Traditionally, Swiss pension fund managers interpret fund managing within the

legal limits as good pension fund management. However, the study has furthermore shown

that over the past decade pension funds have consciously increased their equity and foreign

securities investments. The report of Queisser and Vittas (2000) provides an overview of the

investments returns of the Swiss system compared to other countries. Given the extremely

conservative Swiss approach it is not surprising that the returns of Swiss pension funds are

relatively low. The average real returns on Swiss pension portfolios were 4.90 percent in the

period from 1984 – 1998, whereby other countries such as Ireland, United States and United

Kingdom reported an average real returns of 12.54 percent, 10.49 percent respectively 10.35

percent in the same period.

The paper of Yermo (2003) provides a survey of investment regulation of pension funds

worldwide. The report contains all quantitative portfolio restrictions applied to autonomous

pension funds in OECD countries at legal levels. Antolin (2008) provides an analysis of

aggregate investment performance by country on a risk adjusted basis by using relatively

standard investment performance measures. The paper moreover describes the privately

managed pension funds around the world and the regulatory environment they face. In the

same year Tapia (2008) provides a more comprehensive description of private pension funds

in twenty-tree countries. The report presents a new data set on the investment performance

Literature

6

achieved by privately managed pension funds, including annual real rates of return, annual

geometric average of real returns, as well as a summary of statistic of these returns for various

countries.

The report by Hinz et al (2010) summarizes the effort undertaken by the OECD to compile

information on privately managed pension funds and provides descriptive information on the

design of the pension systems as well as a summary of the different approaches to investment

regulation. The report concludes that the optimal portfolio allocation requires a sophisticated

approach, which includes an intertemporal optimization of pension portfolios, which

considers numerous variables, including the risk of the different financial instruments, age of

individuals, human capital risk and individual preferences. The report points out that policy

makers in various countries feel confident to define a limited number of lifestyle pension

funds differentiated by boundaries on equity exposure is enough to design an optimal path of

accumulation of pension funds. However, the report shows that lifestyle funds are insufficient

to create an optimal path of retirement savings but can create the illusion to contributors that

they are doing so. The report concludes furthermore to built life-cycle funds on well-defined

benchmarks, and, consequently solely impose maximum limits on different asset classes

might not be enough to optimize the future pensions of individuals.

The OECD (2010) report describes the main quantitative investment regulations applied to

pension funds in OECD and selected non-OECD countries. The paper publishing all forms of

quantitative portfolio restrictions with minima and maximum applied to pension funds at

different legal levels. Moreover the report provides a list of the main regulator changes during

2009. Interesting in context of this paper are the changes in BVV2 and OPP2 in Switzerland

during 2009. The ceiling on foreign investments and the foreign asset class sub-limits were

replaced by a single 30 percent ceiling on investments denominated in foreign currency,

whereas hedging activities are allowed. In addition to this the ceiling on real estate was

reduced from 50 percent to 30 percent, while the ceiling on mortgage loans was reduced from

75 percent to 50 percent.

A further report publish by OECD (2011) summarizes the pension funds performance during

2009. The report presents a comprehensive overview on the real average investment rate of

various OECD countries. During 2009, pension funds cross OECD countries realised a

positive real investment rate of 6.5 percent on average, however the average asset values were

still on average 9 percent below the levels of 2007.

Survey of investment constrains of pension funds

7

3 Survey of investment constrains of pension funds and portfolio

allocation

The following section provides an overview of the quantitative investment constrains in

Denmark, Netherlands, Sweden and Switzerland and discusses recent developments within

the regulation body in each system. Moreover the section contains an analysis of the portfolio

allocation and provides an inside to what extend the quantitative investment constrains are

applied in the portfolio allocation of pension funds.

3.1 Denmark

Quantitative limits are in the Danish system applied on the asset side. The restrictions

especially limit the share of assets which can be made in so-called "risky assets", notably

equities. Furthermore quantitative limits are applied in order to decrease concentration of

risks and achieve diversification effects. For example quantitative restrictions are applied to

possible exposure on one issuer of mortgage bonds or the proportion of total assets which

might be invested in the security of just one company or holding company. While quantitative

investment limits are still in place however over the years a gradual move towards regulation

based on the Prudent Person Principle (PPP) continued. The PPP limits emphasis on the

pension institution to behave prudently, controlled and monitoring risk, rather than on

quantitative limits. On the other hand over a longer time period the share of assets which can

be invested in "risky assets" such as equities, has been increased.

In 2001 the limits on the proportion of "risky assets" was raised from 50 percent to 70

percent. The reason for the increase was that some institutions had reached the former ceiling

of 50 percent and still intended to increase the equity proportion. Andersen and Skjodt (2007)

point out that the flexibility in the current Danish investment regulation is so great that asset

allocation strategies are more influenced by internal asset and liabilities considerations or

capital rules rather than by quantitative investment rules and limitations per se (Andersen &

Skjodt, 2007).

The Danish pension funds additionally face quantitative investments constrains on their

investments in equities, bonds, retail investment funds, private investment funds. The

imposed limits from 2001 remain and include an overall limit on equities of 70 percent,

whereby not limits of equity investments in OECD countries exist. The bonds investments are

limited to 70 percent, only if non gilt-edged, in addition private investment funds such as

hedge funds or private equity funds face a limit of 10 percent. All other asset classes are not


8

particular restricted by quantitative investment constrains. Table 2 in Section 6 provides a

summary of the information.

3.2 Netherlands

In contrary to the tree other pension fund systems no quantitative investment constrains are in

place in the Netherlands (OECD, 2010). However relative strong funding regulations are

applied. Pension funds in the Netherlands are obliged to keep their pension promises fully

funded. The Financial Assessment Framework, which is part of the Pension Act, sets out the

requirements of financial position of a pension fund. A pension fund's financial position is

reflected largely by the coverage ratio. The coverage ratio expresses the relationship between

the fund's assets and the pensions to be paid in the future (pension liabilities).

The minimum coverage ratio is 105%. This means that the capital must amount to 105% of

the liabilities. Moreover a pension fund must hold enough equity to be able to deal with

financial setbacks. The size of the buffers on average is approximately 125%. The greater the

investment risks and the higher the average age in the pension fund, the higher the buffer

requirements. In case of a funding shortfall, by definition a coverage ratio less than 105%, the

fund must submit a recovery plan to the Dutch National Bank (DNB). The coverage ratio

must regain the 105% level within 3 years (Funds, 2008).

According to our narrow definition of quantitative investment constrains in this paper, the

coverage ratio cannot by considerate as one. However, we bear in mind that the restrictive

coverage ratio policy within the Netherlands pension fund system could have an indirect

effect on the portfolio allocation and lead to investments with lower standard deviation.

3.3 Sweden

Similar to the Danish or Swiss pension funds, the Swedish pension fund system face

quantitative investments constrains on their investments in foreign currency, bonds or fixed

income instruments, private investment funds and commodities investments.

Swedish pension funds are restricted in foreign currency investments. A maximum of 40

percent of Asset under Management (AUM) are allowed to be exposed to currency risk,

exposure beyond 40 percent must be hedged. The restriction is in place due to that face that

the liabilities of pension funds are denominated in domestic currency and typically Swedish

equities are strongly exposed to currency risks.

According to the quantitative restrictions Swedish pension funds are moreover obliged to hold

at least 30 percent of AUM in fixed income instruments, whereby only fixed income


9

instruments with a low credit- and liquidity risk are permitted. Only Government or corporate

bonds with a high investment grade fulfil the restrictions. A third quantitative restriction

limits the maximum amount invested in so-called Non-listed Assets. The restriction limits the

amount of Non-listed Assets at a maximum of 5 percent, whereby only Funds or Funds of

Funds investments with related to Private Equity and Infrastructure are allowed. Furthermore

only funds with a transparent performance measurement are part of the permitted assets.

However, the restriction excludes Real Estate investments. In contrary to investment

constrains of other counties are all investments in commodities not allowed in the Swedish

system. The investment in commodities are not considered as a conservative investment and

therefore typically not part of "traditional" portfolios of institutional investors.

Additional to the quantitative restrictions at level o the asset classes further regulations within

the asset classes are in place. The restriction with the asset classes impact the asset allocation

not directly, however are mentioned in terms of completeness.

First of all it's not allowed to invest more than 10 percent of the AUM in a single counterparty

or group of counterparties. Second, a maximum of 10 percent of voting rights in one single

company can be hold. Third, the total market value of Swedish public equity may not exceed

2 percent of total market capitalisation. Fourth, a minimum of 10 percent of AUM must be

managed by external managers to ensure cost efficient management of the other assets

(Franzen, 2008). The Table in the appendices summarizes the above information.

3.4 Switzerland

The Swiss Federal Law on Occupational Old-age, Survivors and Disability Pension Plan

(LPP) contains regulations which Swiss pension funds must apply for their investments.

According to the investment principles pension funds asset have to be managed prudently to

ensure the safety of assets, achieve a reasonable return on investment assets, substantial

diversified of risk, and allow for the liquidity requirement of the plan1.

The Swiss pension funds additionally face quantitative investments constrains on their

investments in equities, bonds, mortgages and real estate. The currently imposed limits

include an overall limit on equities of 50 percent including domestic and international

equities. However, the regulation contains sub-limits on the foreign equities. In 2009 the 30

percent ceiling on foreign investment and foreign asset class sub-limits were replaced by a

single 30 percent ceiling on investment denominated in foreign currency, whereby currency

1 Article 50 of the Swiss Federal Law on Occupational Old-age, Survivors and Disability Pension Plan. In

addition, Articles 49-60 of the Ordinance on the Occupational Old-age, Survivors and Disability Benefit Plans

(OOB2).


10

hedging is allowed. In addition the ceiling on real estate was reduced from 50 percent to 30

percent and the ceiling on mortgage loans was reduced from 75 percent to 50 percent2

(OECD, 2010). Furthermore a sub-limit on real estate in foreign counties exists, maximum

one third of the real estate investments are allowed in foreign countries. Moreover alternative

investments are now authorised as a possible type of investment with a ceiling of 15 percent.

However, the latter must be made via a diversified investment vehicle and may not incur any

reserve liabilities. In addition the new regulations to prevent the concentration of risks in

single investment classes and to allow international diversification of pension fund

investments are installed. The limits on investments in individual firms or with individual

debtors were set at five and ten percent respectively, irrespective of their nationality3.

In a recent article Ammann and Zingg (2008) point out the quantitative limitations influence,

in particular, the strategic asset allocation of pension funds. Amman and Zingg (2008, p.35)

conclude that "the quantitative limitations, even if exemptions have become the rule,

influence the asset allocation of Swiss pension funds to a great extent. The vast majority of

pension funds in Switzerland structure their assets in domestic bonds, international bonds,

domestic equities and international equities. This partially explains the strong home bias of

Swiss pension funds" (Ammann & Zingg, 2008). Furthermore they conclude that the

quantitative investment constrains are less important for the investment strategy within the

individual asset classes.

3.5 Summary investment constrains

The section summarizes the above explanations. In contrary to all other countries Netherlands

have no quantitative investment constrains, however relative strong funding regulations are

applied. According to the definition the coverage ratio is not quantitative investment

constrains, but in the portfolio analysis we bear in mind that the coverage ratio could lead to

prudent investments.

All other three pension fund system face quantitative investments constrains. The Danish

pension fund have quantitative investments constrains on their investments in equities, bonds,

retail investment funds, private investment funds. The bonds investments are limited to 70

percent and in addition private investment funds such as hedge funds or private equity funds

face a limit of 10 percent.

2 Article 55 of the Swiss Federal Law on Occupational Old-age, Survivors and Disability Pension Plan

3 Article 54 and 55 of the Swiss Federal Law on Occupational Old-age, Survivors and Disability Pension Plan


11

Swedish pension funds are restricted in foreign currency investments. A maximum of 40

percent of Asset under Management (AUM) are allowed to be exposed to currency risk,

exposure beyond 40 percent must be hedged. Further restrictions limit the amount of Non-

listed Assets at a maximum of 5 percent, whereby only Funds or Funds of Funds investments

with related to Private Equity and Infrastructure are allowed.

Only Government or corporate bonds with a high investment grade fulfil the restrictions. A

third quantitative restriction limits the maximum amount invested in so-called Non-listed

Assets. The Swiss pension funds additionally face quantitative investments constrains on their

investments in equities, bonds, mortgages and real estate, an overall limit on equities of 50

percent including domestic and international equities. However, the regulation contains sub-

limits on the foreign equities. In 2009 the 30 percent ceiling on foreign investment and

foreign asset class sub-limits were replaced by a single 30 percent ceiling on investment

denominated in foreign currency, whereby currency hedging is allowed. In addition the

ceiling on real estate was reduced from 50 percent to 30 percent and the ceiling on mortgage

loans was reduced from 75 percent to 50 percent4 (OECD, 2010).

According to our analysis of the investment constrains we could expect a more aggressive

portfolio allocation in countries like Netherlands and Denmark, a balance portfolio allocation

with some alternative investments in Switzerland and prudent portfolio allocation in Sweden.

3.6 Portfolio allocation of Denmark from 2001 – 2009

The Danish pension system applied quantitative limits are set with respect to the allocation

within “risky assets” referring in most cases to the equity allocation. Further are there limits

with respect to the so-called correlation risk, with the goal to diversify the concentration on

the assets issued by counterparties. The focus on the diversification amongst the issuing

counterparties got the focus at the latest with the recent financial crisis including the

bankruptcy of one of the largest player within the banking system, Lehman Brothers. The

rules in the Danish pension system led to the following historical development of their asset

allocation.

The safest asset class within the entire asset allocation is the so-called “cash and deposits”.

The cash part includes current account and other short-term savings in the financial system,

while deposits are considered as fund “placed on deposit” with a financial institution and does

not include certificates of deposits or other short-term securities. This allocation lies within

4 Article 55 of the Swiss Federal Law on Occupational Old-age, Survivors and Disability Pension Plan


12

the range of 0.3 percent and 2 percent with an average of 0.75 percent during the time series

available. This low allocation is reasonable as the return generated are extremely low.

The traditional fixed income allocation into bills and bonds issued by both the public and

private sector makes by far the largest part of the entire asset allocation observed by the

Danish pension system. This part consist of bills and bonds issued by the public

administration both local governments and national debt. The allocation over the observed

time series moves from 47 percent up to 70 percent of the entire portfolio with an average

around 54.8 percent. After the recent financial crisis in 2007 a strong increase to this

allocation could be observed at the expense of the equity allocation.

The loans allocation consisting of consumer credit, bank loans, mortgage loans, financial

leases and other kind of loans including commercial bills, hire purchases and other instalment

credits and further types of loans not bound to bearer bonds. The allocation ranges within 0.01

percent up to 1.45 percent at the aftermath of the financial crisis with an average of 0.21

percent. The conclusion for the strong increase after (during) the financial crisis could be that

the Danish pension fund managers saw opportunities within the loans market as result of the

irrational behaviour of the financial market participants. The allocation into equities the so-

called “risky assets” got in 2001 elevated to a cap of 70 percent instead of the old ceiling of

50 percent. The ranges into this allocation lies within 11.55 percent up to 39.72 percent with

an average around 24.88 percent. Two interesting observation are that first of all the new as

well as the old cap of 70 percent resp. 50 percent was never touched. This leads to the

conclusion that the Danish pension fund manager did never capitalize on the full allowed

investment allocation into equities. Second of all was during the financial crisis of 2007 the

allocation almost the highest with 30.72 percent over the time series available. This leads to

the conclusion that the market timing of the Danish pension managers is at least not optimal.

The allocation into land and building consist of real estate including lands, buildings and

other improvements owned by the pension funds. This allocation mostly consists of real

(physical, hard) asset and display an adequate inflation protection. The allocation into this

asset class ranges within 1.27 percent up to 2.74 percent with an average around 1.96 percent.

The allocation remains more or less stable over the observed time period. The allocation into

mutual funds compromise both retail and institutional funds that can be open-end as well as

closed end. The allocation ranges from 2.4 percent up to 16.31 percent. While a constant

decrease in the assets allocated to mutual funds can be observed since the recent financial

crisis. The allocation into the part named as “other investments” consists of all financial assets

not included in the other categories namely derivatives, trade credits and other accounts


13

receivables and payables. This part experienced a constant annual increase since 2001 with

0.04 percent up to its peak allocation in 2008 with 24.67 percent with an average of 8.32

percent.

Figure: 1: Asset Allocation Denmark 2001-2009

Source: OECD (2011)

3.7 Portfolio allocation of Netherlands from 2001 – 2009

No quantitative investments constrained are attached to the asset management within the

Netherlands pension system. The allocation into cash and deposits in Netherlands pension

system lies between 0 percent up to 4.31 percent with an average around 2.72 percent. The

traditional fixed income allocation into bills and bonds issued by both the public and private

sector makes by far the largest part of the entire asset allocation observed by Netherlands

pension system, the ranging from 35.04 percent up to 43.54 percent with a more or less stable

allocation over time. The allocation into loans seems more present comparing to the Danish

pension system, with a range of 2.78 percent up to 8.09 percent with an average of 4.55

percent. The allocation into risky assets, namely equity lies between the range of 8.39 percent

and 47.80 percent at its peak. Interesting is the allocation into mutual funds which was from

2001 up to 2008 not existent and experienced a strong inflow in 2009 with a allocation of

32.26 percent. The allocation into “other investments”, namely all investments that cannot be

imputed to the other categories range from 2.86 percent up to 15.42 percent.

Denmark 2001 Denmark 2002 Denmark 2003 Denmark 2004 Denmark 2005 Denmark 2006 Denmark 2007 Denmark 2008 Denmark 20090%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Asset Allocation Denmark 2001 - 2009

Other investments

Mutual funds (CIS)

Land and Buildings

Loans

Shares

Bills and bonds issued by public

and private sector

Cash and Deposits


14

Figure: 2: Asset Allocation Netherlands 2001-2009

Source: OECD (2011)

3.8 Portfolio allocation of Swedish from 2001 – 2009

As already prior mentioned the Swedish pension system faces similar quantitative investment

constraints as the Danish or Swiss system mainly on their investment in foreign currency,

bonds or fixed income instruments, private investment funds and commodities investments.

The allocation into cash and deposits of Swedish pension portfolio lies between 1.16 percent

and 3.0 percent with an average around 1.75 percent. This is in line what can be observed in

the allocation of the Danish and Netherlands systems.

The traditional fixed income allocation into bills and bonds issued by both the public and

private sector makes by far the largest part of the entire asset allocation observed by Swedish

pension system as with the other ones. The ranging from 45.97 percent up to 65.16 percent is

more or less stable allocation over time. The allocation into loans seems less present

compared to the observation of the one in the Netherlands, with a range of 0.00 percent up to

3.52 percent with an average of 0.64 percent. The allocation into risky assets, namely equity

lies between the range of 12.42 percent and 35.52 percent at its peak with an average of 25.90

percent. Interesting is the allocation into mutual funds which was started only in 2006 with an

allocation of 8.00 percent steady increasing up to 27.47 percent in 2009 with an average of

15.43 percent. The allocation into “other investments”, namely all investments that cannot be

imputed to the other categories range from 0.16 percent up to 12.73 percent with an average

of 4.32 percent.

Netherlands 2001 Netherlands 2002 Netherlands 2003 Netherlands 2004 Netherlands 2005 Netherlands 2006 Netherlands 2007 Netherlands 2008 Netherlands 20090%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Asset Allocation 2001 - 2009

Other investments

Mutual funds (CIS)

Land and Buildings

Loans

Shares


and private sector

Cash and Deposits


15

Figure: 3: Asset Allocation Sweden 2001-2009

Source: OECD (2011)

3.9 Portfolio allocation of Switzerland from 2001 – 2009

The cash and deposit allocation within the Swiss pension systems exhibits compared to all

other pension fund systems a relatively high average of 8.68 percents. The allocation ranges

between 7.66 and 9.95 percent. Due to the lack of performance date no statistical conclusion

can be taken, but the high cash and deposit allocation surly drags on the overall portfolio

performance as this asset cash exhibits the lowest return due to the high liquidity. The

allocation to bills and bonds ranges from 23.90 and 29.28 percentage with an average of 26.77

percent. The Swiss pension system is within the allocation to loans again an outlier with

allocation ranging from 4.35 up to 11.19 percent, exhibiting an average of 7.15 percent. The

average allocation to risky assets, notably shares, is 17.45 percent with a minimum of 11.67

and a maximum of 23.64 percent over the observed time horizon. The allocation to hard

assets, notably land and building is on average 10.60 percent, ranging from 9.38 up to 12.29

percent. The average investment into mutual funds within the Swiss pension system is 25.46

percent. This allocation moved between 16.26 and 36.57 percent. The allocation to other

investments, not classified in one of the other asset classes, exhibits a low allocation of

around 0.83 percent on average when compared to the other observed systems. The range

over lies between 0.56 and 1.20 percent. In none of the other analyzed pension systems was

an allocation into private investment funds. This asset class consists of private partnerships

and other institutional investment arrangements open only to qualified investors. The Swiss

pension funds have on average an allocation of 3.72 percent and ranged from 2.80 up to 4.50

Sweden 2001 Sweden 2002 Sweden 2003 Sweden 2004 Sweden 2005 Sweden 2006 Sweden 2007 Sweden 2008 Sweden 20090%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%


Other investments

Mutual funds (CIS)

Land and Buildings

Loans

Shares


and private sector

Cash and Deposits


16

percent. It's not clear in the classification if in the other pension systems the allocation into

private partnerships and other investment arrangements was allocated to "other investments".

Figure: 3: Asset Allocation Switzerland 2001-2009

Source: OECD (2011)

Switzerland 2001 Switzerland 2002 Switzerland 2003 Switzerland 2004 Switzerland 2005 Switzerland 2006 Switzerland 2007 Switzerland 2008 Switzerland 20090%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%


Private investment funds

Other investments

Mutual funds (CIS)

Land and Buildings

Loans

Shares

Bills and bonds issued by public and

private sector

Cash and Deposits

Description of data

17

4 Data

The former evaluation of the various quantitative investment constraints for the different

pension systems was based on the data obtained by the OECD. Even though the data is

consistent in regard to the definition of the various asset classes allowing to perform a

comparison of the different pension systems, a quantitative analysis based on portfolio

statistics was not possible with the available data of the OECD. Thereby, some restrictions on

the data have to be taken into account. First, different time horizons were applied for the data

of different countries. Consequently, only aggregated data for different time horizons was

available and the last coherent survey over all OECD country pension systems was only

available until December 2005 (OECD, 2008). Second, even thought the used return data for

the individual asset classes was available from the OECD, the definition of the asset classes

was not consistent among the different asset allocations done by the pension systems. As an

example, OECD defines cash and deposits as current accounts and other short-term savings.

Thereby, the do not include certificates and of deposits or other short-term deposits. However,

a precise definition of short-term assets is not provided by Davis (2002). Therefore, the

comparability of the returns to the respective asset classes (in regard to the asset allocation)

was not possible. Given this constraints in the statistical evaluation of the different pension

system we dismissed this evaluation as no coherent data basis was given.

Conclusion

18

5 Conclusion

The paper analysed four state-of-to-art pension fund systems in Europe and analysed the

investment constrains in each system, whereby we choose the Denmark, Netherlands, Sweden

and Switzerland. The chosen the four pension fund system due to the similarities in the

pension fund structure and the economic characteristics of the countries.

The findings of the paper is three out four analysed pension fund systems applied quantitative

investment constrains. Opposite to the system applied within the Netherlands where there are

no quantitative investment constrains at all. However, in the Netherlands the regulator

restricts the pension funds no with quantitative restriction but they have to follow restrictive

coverage ratios, which are not classified as quantitative investment restriction like it's the case

for the pension system evaluated in the other three countries, but still limit indirectly the

investment freedom of the pension system. The pension fund regulators in Denmark,

Switzerland and Sweden decided to restrict the investment freedom of their pension funds

with quantitative limits. Therefore, there exist quantitative limits on the maximum exposure

that can be taken within the universe. First, there are limits with respect to the investment

exposure within the domestic and foreign financial markets. Taking into account the fact that

the pension funds liabilities are in the respective local currency and a to high exposure in

foreign investments bears a currency risk which has the potential to decrease the asset side of

the balance sheet not due to the performance of the investments but due to the devaluation of

the foreign currency. Secondly, there are limits with respect to the maximum exposure into a

single asset classes ensuring a broad diversification across the pension fund portfolio. The

only asset class not targeted by the quantitative restriction is cash. Thirdly, there are limits

with respect to the maximum exposure a pension funds can have to a single counterparty

ensuring a broad diversification across the issuer of financial instruments. Overall the pension

funds have to follow rules regarding the liquidity risk within his portfolio as ongoing pension

liabilities have to be covered. This limits can be seen in the lower maximum exposure that can

be taken within the alternative investment allocation, which have historically shown to be less

liquid compared to bonds and equities, where larger investment exposure are possible.

However, despite all this quantitative investment constraints in place there was no case were a

pension fund system in one of the countries effectively invested up to the maximum exposure

allowed by the respective regulator over the analyzed time horizon. This observation lets to

Conclusion

19

the conclusion that no final conclusion can be taken on the effective influence of quantitative

investment constraints on the performance of the analyzed pension fund system of the various

countries. Despite the missing data needed for the analysis of the pension fund portfolio

statistics this conclusion can be taken.

The comparison of the pension fund system across four countries leads to following final

conclusion that the pension funds in neither of the analyzed countries exploit the full potential

of the quantitative investment constraints. Further, the hypothesis has to be tested if instead of

quantitative investment constraints the long term pension fund performance is driven by the

benchmark which the pension funds are evaluated against.

Appendices

20

6 Appendices

Table 2: Portfolio limits of pension funds in selected asset categories

Country Equity Real Estate Commodities Bonds Retail Investment

Funds

Private Investment

Funds

Loans Bank deposit

Denmark - 70% - No limit

(if gilt-edged)

- No limit,

however Max.

10% in hedge

funds

- No limit (if gilt-

edged), 70% (if non

gilt-edged)

- 70% (no limit, for

UCITS with only

listed gilt-edged bonds

as underlying assets)

- 10% hedge funds,

private equity funds and

other funds

- No limit (if gilt-

edged)

- 2% (if non gilt-

edged)

- No limit

Netherlands - No limit - No limit - No limit - No limit - No limit - No limit - No limit - No limit

Sweden - 70%

- FSR: 0%

- IR: 25% (if

quoted)

10% (if

unquoted)

- OP: no limit

if quoted, 10%

in unquoted

- FSR: Allowed,

but only up to

4/5 or 2/3 of

rateable value,

depending on

type of estate, or

70% or 60%,

respectively, of

the estate's

estimated

-No allowed - FSR: no limit

(other bonds than

those issued by a

state or of equal

quality must be

issued by a credit

institution or be

guaranteed by such

an institution

-IR: no limit if issued

by a state or of equal

- At least 30% shall

be invest in fixed-

income securities

- FSR: 0%

- IR: Investments can

only be made in funds

that primarily invest in

assets that would be

allowed for direct

investments. The type

of assets in the fund

must be added to

directly owned assets

of the same type and

the total not

- FSR: 0%

- IR: Investments can

only be made in certain

funds that primarily

invest in assets that

would be allowed for

direct investments. The

type of asset in the fund

must be added to

directly owned assets.

- FSR: no limit (only

loans with some

form of mortgage

guarantee or equal

security are allowed

unless the debtor is

the Swedish state or

s Swedish

municipality)

- IR: No limit if the

debtor is a state

- FSR: 0%

- IR: 75%

- OP: No limit

Switzerland - 50% (overall

limit in

equities)

- 30% overall

limit

- No limit, but

Max 10% in

alternative

investments

- No limit - No information, but

Max. 10% in

alternative

investments

- No limit, but Max.

10% in alternative

investments

- 50% mortgage

(maximum of 80%

of market-value of

the real estate)

- 10% per bank (no

overall limit)

Appendices

21

Table 3: Portfolio limits on pension funds investments in foreign asset categories

Country Global investment

limit in foreign

assets

Equity Real

Estate

Bonds Retail Investment

Funds

Private Investment

Funds

Loans Bank deposit

Denmark - No limit for OECD

countries

Netherlands - No limit

Sweden - Not more than 40%

may be exposed to

currency risk

Switzerland - 30% foreign

currency (hedging

allowed)

-10%

Table 4: Other quantitative investment regulations on pension fund assets

Country Investment limit in single issuer/issue Self-investment / Conflicts of

interest

Other quantitative rules Ownership concentration limits

Denmark - Max 3% in securities issued by a single issuer

(general rule). 2% for small non-listed companies.

- Max. 40% in mortgage bonds issued by a single

issuer

- Max. 10% in receivable amounts issued by a single

bank.

- Max. 10% in units in a branch of an investments

fund or in a investment fund

653- Max. 10% in Contracts of reassurance issued by

a single issuer

- Max. 10% in loans issued by a single issuer

- Minimum 80% currency matching

requirement. Euro can match up to

50% of other EU currencies (e.g.

DKK) than Euro.

-Ownership is limited to carry out activities ancillary to

the activities licensed.

-It is allowed, through subsidiaries, to carry out other

financial activities.

-It is allowed temporarily to carry out other activities to

secure or phase out exposure already entered into, or with

regard to restructuring enterprises.

-It is allowed to carry out the following activities:

1. Agency activities for insurance companies under the

supervision of the Danish FSA.

2. Establishment, ownership and operation of real

Appendices

22

- Max. 5% for investment in a single property property as a long-term placing of funds.

Netherlands -Diversification is required, but no quantitative rules -Max. 5% may be invested in shares

of the sponsoring employer, in case of

exceeding assets; it can be 10%

maximum

-None -None

Sweden - FSR limits: none.

- IR and OP limits:

- No limit for bonds issued by and loans granted to a

state or an equally financially stable subject.

- Max. 5% (10% if the total of these investments does

not exceed 40% of the technical provisions and shares

from the same issuer does not exceed 5% of these

provisions) in shares, bonds issued by a single

company and loans granted to the same subject.

- Max. 5% in a single piece of real estate (or group

of).

-Max. 10% in a single investment fund

- FSR limits: none

- IR limits: none

- OP limits: investment in the

sponsoring undertaking shall be no

more than 5% and when the

sponsoring undertaking belongs to

group, investment in the undertaking

belonging to the same group as the

sponsoring undertaking shall not be

more than 10% of the portfolio

- FSR limits: No investments in

derivatives allowed.

IR limits: see first table. No

derivatives in assets held to cover

technical provisions. Max. 20% in

assets denominated in currencies

other than the currency in which the

liabilities are denominated.

OP limits: Risks related to currency

matching have to be limited

- FSR limits: none

- IR limits: none

- OP limits: none

Switzerland - Max. 15% (5% for foreign assets) in debt

instruments (except governments bonds, banks and

insurance companies) issued by a single issuer

- Max. 10% (5% for foreign assets) in equities of a

single company.

- Max . 5% may be invested in the

sponsoring employer.

- Investment in derivatives for

hedging purposed only.

- With a founded explanation

the quantitative limits may be

exceeded

- Limits of foreign currency of

30%

None

References

23

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