The investment strategies of the various earnings-related pension insurance companies generally appear to be very similar. The differences in terms of the asset allocation in the portfolio are often minimal and, in many cases, the quarterly reported investment returns end up being fairly close to one another across all companies. Would it be reasonable then to abandon the institutional decentralisation of investment activities within the earnings-related pension system if all of the pension insurance companies are anyway ending up with similar investment strategies?
The implementation of the statutory earnings-related pension scheme in Finland is decentralised to private-sector pension insurance companies and pension funds as well as to public-sector pension insurers. Each actor invests the pension assets in their control in accordance with their own investment strategy and with the aim of achieving the best possible return at the risk level allowed by the system. The decentralisation of investment activities to several actors increases costs to some extent. On the other hand, from the perspective of the diversification of investment risks and increased efficiency as a result of mutual competition, the grounds for decentralisation are highly justified.
Earnings-related pension companies report on the returns and asset allocation of their investments on a quarterly basis. On a global scale, the level of transparency is high and it facilitates comparisons of success regarding the investment strategies of pension insurance companies and boosts competition among those companies. In the international Mercer Global Pension Index comparison, Finland’s earnings-related pension system has, indeed, been rated seven times over as the world’s most reliable and transparent system. Could this comprehensive transparency lead to a situation in which the earnings-related pension companies all end up with the same types of investment strategies and the diversification of investment risks suffers at the level of the overall pension system?
The pandemic has highlighted differences in investment strategies
Normally, the differences between the overall investment returns achieved by the earnings-related pension companies have been relatively small, even though there are, within asset classes, differences in investment returns as a result of different investment strategies. One reason for this may be the averaging effect of randomisation within a diversified portfolio. It is namely rare that an individual actor comes out on top in multiple asset classes at the same time. Another natural reason is that all earnings-related pension companies are subject to the same required rate of return, which guides their investment allocations in the same direction. Furthermore, solvency legislation limits the taking of excessive risks, which leads to similar risk levels across the pension companies.
The 2020 reporting of investment returns by pension companies indicated exceptionally large differences between the different actors. The coronavirus crisis that took hold at the end of February and the subsequent massive stimulus measures caused substantial market movements. The resulting turmoil in the financial markets showed that there are notable differences in the investment strategies of the pension companies, but these differences had not been realised within a normal, calmer market environment. It appears that different investment strategies will only be tested in volatile market conditions when diversification, which works well under normal conditions, loses its effect. This is also what happened in the global financial crisis in 2008.
Open competition improves the response to changes in the financial markets
The open and transparent reporting of the investment activities within the earnings-related pension system has, during the past year, highlighted the strengths and weaknesses of the investment strategies of the pension companies in a rapidly changing market situation. It forces mutually competitive pension companies to continuously reflect inward and adjust their investment beliefs daily as the market environment evolves. Also in the long term, competition has a positive impact on investment strategies and returns.
As with the rest of society, the financial markets are also undergoing continuous changes and investors must, as time goes forward, adapt their own investment strategies to correspond to these changes. Within a centralised pension system, it would be a great risk for a single investor to get hung up on one investment ideology and believe it unflinchingly, while the world surrounding that system is changing. Only open and transparent competition will make investors genuinely question their own success factors in the future.
The entire earnings-related pension scheme ultimately benefits from the open and transparent mutual competition between pension institutions in the form of increased efficiency and more timely investment strategies. Higher investment returns improve the financial sustainability of the earnings-related pension scheme, which, in turn, means more moderate pension insurance contributions and the securing of benefits over a longer time period.