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Pension Reform, Investment Restriction, and Capital
Markets
By Jorge E. Roldos
(summarized by: Yudha & Riko)
Introduction
• Pension reform in several emerging market countries has been
associated with rapid growth in assets under management and a
positive impact on the development of local securities markets. i.e :
Chile
• Critical Element for Pension Issues according to Mitchel & Barreto:
– whether the system has to be mandatory or voluntary,
– how it is to be financed
– how should benefits be structured
– the size and financing of the transition
– performance and regulatory structure of the system.
• The paper stresses the tradeoffs between optimal portfolio
diversification and the development of local securities markets
How Pension Works
• Pension funds provide means of risk pooling for smaller individual investors,
thus providing diversification and enhanced risk-return opportunities for end-
investors.
• Able to absorb and process information & transact in large volumes
• providing better risk management, lower transaction costs, and in long-term
allow to invest in and contribute to the development of longer-term
securities markets.
• It also contributes to better transparency and governance, as well as to the
improvement of market microstructure and the adoption of innovative
financial products
Pension Fund & Capital Market Development
• Institutional investors’ assets in
the G-7 countries increased from
23 percent in 1970 to 108
percent of GDP in 1998
• Over the long term, pension
funds have grown faster than
other types of institutional
investors
• The increasing importance of
institutional investors has been
accompanied by an increase in
the relative importance of equity
and bond markets, at the
expense of bank deposits
Pension Fund Contribution
• The rapid growth of assets
managed by private pension funds
having a positive impact on the
development of local securities
markets
• Chile creates of a long-run market
in corporate bonds (Cifuentes, et al
2002). The average maturity of
bond issuance was between 10-15
years in the first half of the 1990s,
and more recently it has been
between 10 up to 30-year bonds
• Pension funds have also had a
significant impact on Chile’s stock
market
Outlook Risk & Challenges
• When local stock markets are small (as is particularly the case in
most Latin American countries), with a limited number of qualifying
companies, rapidly growing funds will quickly reach these limits,
increasing the risk of price bubbles (growing imbalance between the
demand and supply)
• Regulatory limits on investments in stocks and foreign assets could
also distort asset prices and magnify price volatility
• The growing imbalance between AUM and available securities, and
the associated distortions and risks, pose a policy dilemma: whether
to improve capital market regulations to speed up the development
of local securities markets, or to loosen pension fund portfolio
restrictions
Investment Restriction
Goals : protecting workers’
future pension benefits
strict regulations in aspects
of the industry structure,
asset allocation, and
relative performance
Invest in most conservative
instrument: Domestic
Bonds, smaller in stocks
and foreign securities
Conclusion & Remarks
• As in the mature markets, pension funds’ assets under management (AUM)
have been growing at a rapid pace in emerging markets that have
implemented pension reforms
• The growth in AUM has been associated with quantitative and qualitative
benefits for local securities markets. In contrast to the mature markets,
benefits have been concentrated to a large extent in local bond markets
• The growing imbalance between the demand and supply of local securities
markets could cause significant distortions in asset pricing, concentrations
of risk exposures, and asset price bubbles.
• Limits on equity holdings and corporate bonds could be gradually relaxed as
local asset managers become used to risk management techniques
• As pension funds tend to exhibit herding behavior, a switch to foreign assets
by an industry leader is likely to lead to strong pressures in the foreign
exchange market, suggesting that close monitoring of funds and an
appropriate timing of regulatory changes in investment limits are essential

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Pension Fund, Investment Restriction and Capital Market

  • 1. Pension Reform, Investment Restriction, and Capital Markets By Jorge E. Roldos (summarized by: Yudha & Riko)
  • 2. Introduction • Pension reform in several emerging market countries has been associated with rapid growth in assets under management and a positive impact on the development of local securities markets. i.e : Chile • Critical Element for Pension Issues according to Mitchel & Barreto: – whether the system has to be mandatory or voluntary, – how it is to be financed – how should benefits be structured – the size and financing of the transition – performance and regulatory structure of the system. • The paper stresses the tradeoffs between optimal portfolio diversification and the development of local securities markets
  • 3. How Pension Works • Pension funds provide means of risk pooling for smaller individual investors, thus providing diversification and enhanced risk-return opportunities for end- investors. • Able to absorb and process information & transact in large volumes • providing better risk management, lower transaction costs, and in long-term allow to invest in and contribute to the development of longer-term securities markets. • It also contributes to better transparency and governance, as well as to the improvement of market microstructure and the adoption of innovative financial products
  • 4. Pension Fund & Capital Market Development • Institutional investors’ assets in the G-7 countries increased from 23 percent in 1970 to 108 percent of GDP in 1998 • Over the long term, pension funds have grown faster than other types of institutional investors • The increasing importance of institutional investors has been accompanied by an increase in the relative importance of equity and bond markets, at the expense of bank deposits
  • 5. Pension Fund Contribution • The rapid growth of assets managed by private pension funds having a positive impact on the development of local securities markets • Chile creates of a long-run market in corporate bonds (Cifuentes, et al 2002). The average maturity of bond issuance was between 10-15 years in the first half of the 1990s, and more recently it has been between 10 up to 30-year bonds • Pension funds have also had a significant impact on Chile’s stock market
  • 6. Outlook Risk & Challenges • When local stock markets are small (as is particularly the case in most Latin American countries), with a limited number of qualifying companies, rapidly growing funds will quickly reach these limits, increasing the risk of price bubbles (growing imbalance between the demand and supply) • Regulatory limits on investments in stocks and foreign assets could also distort asset prices and magnify price volatility • The growing imbalance between AUM and available securities, and the associated distortions and risks, pose a policy dilemma: whether to improve capital market regulations to speed up the development of local securities markets, or to loosen pension fund portfolio restrictions
  • 7. Investment Restriction Goals : protecting workers’ future pension benefits strict regulations in aspects of the industry structure, asset allocation, and relative performance Invest in most conservative instrument: Domestic Bonds, smaller in stocks and foreign securities
  • 8. Conclusion & Remarks • As in the mature markets, pension funds’ assets under management (AUM) have been growing at a rapid pace in emerging markets that have implemented pension reforms • The growth in AUM has been associated with quantitative and qualitative benefits for local securities markets. In contrast to the mature markets, benefits have been concentrated to a large extent in local bond markets • The growing imbalance between the demand and supply of local securities markets could cause significant distortions in asset pricing, concentrations of risk exposures, and asset price bubbles. • Limits on equity holdings and corporate bonds could be gradually relaxed as local asset managers become used to risk management techniques • As pension funds tend to exhibit herding behavior, a switch to foreign assets by an industry leader is likely to lead to strong pressures in the foreign exchange market, suggesting that close monitoring of funds and an appropriate timing of regulatory changes in investment limits are essential