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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
alain.kunz@student.unsgi.ch
05-608-542
Mauro Baertsch
mauro.baertsch@student.unisg.ch
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
Survey of investment constrains of pension funds
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
Survey of investment constrains of pension funds
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).
Survey of investment constrains of pension funds
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
Survey of investment constrains of pension funds
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
Survey of investment constrains of pension funds
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
Survey of investment constrains of pension funds
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
Survey of investment constrains of pension funds
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
Bills and bonds issued by public
and private sector
Cash and Deposits
Survey of investment constrains of pension funds
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%
Asset Allocation 2001 - 2009
Other investments
Mutual funds (CIS)
Land and Buildings
Loans
Shares
Bills and bonds issued by public
and private sector
Cash and Deposits
Survey of investment constrains of pension funds
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%
Asset Allocation 2001 - 2009
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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