Last week, the Russian government made a decision to extend its moratorium on allocations to the accumulative component of retirement pensions until 2015. Instead, all contributions to compulsory pension schemes will be used to finance the insured part of the pensions only.
The Russian government tends to avoid risks associated with investing the accumulative component of retirement pensions. «During the past three years, the accrual of the insured part of pensions though indexation was twice as high as the average return on investing the accumulative part,» according to Anton Drozdov, Head of the Russian Pension Fund. Thus, when risks are high and investment income low, investing the accumulative part of pensions is not feasible. Poor management and unclear regulation are thought to be the main contributors to this problem.
However, a study conducted by Alexander Nepp, Assistant Professor at the Ural Federal University, Polina Kryuchkova, Leading Research Fellow at the Laboratory of Competition and Antimonopoly Policy of the HSE's Institute for Industrial and Market Studies, and Alexander Semin, Professor of the Russian State Professional and Pedagogical University (RGPPU) studied the performance data of Russian and OECD countries' non-state pension funds (NPFs) and found that excessive regulation and incompetent management are not the whole story. Russian NPFs could achieve a positive rate of return on investment if only they were not so scared of risk and could expand the geography of investment, according to their study Investment Risks in the Institutional Environment of Russia's Pension Insurance System: A Comparison with the OECD Countries.
Between 2004 and 2011, the Russian national pension system faced a 61.9% real reduction in the cost of savings, and only four of the 68 managing companies achieved a rate of return higher than the rate of inflation. Nepp believes that Russian NPFs' preference for low-risk assets was behind the poor performance. «Compared to other countries, Russian NPFs take minimal risks,» he notes. In fact, their investment decisions are restricted by Russian law, which prohibitsany investment of pension funds in high-risk – and thus high-yield – assets. Indeed, preference for lower risk at the expense of investment returns is required by law.
By the end of 2012, Russian NPFs' investments included: rouble deposits with banks, 38.9%; domestically issued bonds, 34%; government issued securities, 9.9%; bank account balances, 7.3%; shares, 6.3%; and other assets, 3.6%.
The researchers consider it a paradox that shares only come fifth on the list and account for just 6.3% of all investments, while 90.1% of all pension savings are invested in highly conservative debt instruments.
This policy is due to the higher volatility of Russian bond and stock markets when compared to China, India, and Brazil, let alone OECD countries – which, according to Russian officials, significantly increases the risk of pension investments.
A study of other countries' pension fund investments reveals, however, that negative returns are not specific to Russia; the performance of pension funds differs even between countries with similar stock and bond markets dynamics and external macroeconomic environments.
According to Nepp, Kryuchkova, and Semin, high returns are not always associated with high risks. Thus, while Poland enjoys maximum real returns on investment, it is not a particularly high-risk market; similarly, Portugal with its minimal rates of return is not the lowest-risk market.
However, of all the countries studied, Russia's investment of pension savings was characterised both by minimal investment risks and minimal rates of return, with -0.03% vs. 5.8%, the OECD countries' average. Countries with the highest real rates of return include Norway (8.1%), Poland (7.7%), and Mexico (7.5%), while the lowest rates of return are reported in Portugal (4.1) and Belgium (4.5%).
Table 1. Real (net of inflation) returns on pension funds' investment in OECD countries
Having analysed the market volatility and relative yields of different investment instruments, the researchers found there was a positive impact from portfolio diversification on returns. «An investment portfolio comprising a variety of assets with different risks and returns allows risk minimisation with increased rates of return,» Nepp explains. Using this approach makes it possible to move from negative to positive returns on pension savings.
Diversification, however, should not be limited to domestic investment instruments. «Greater geographical scope of investment will enable pension funds to improve their key performance indicators, i.e. pension payments and the replacement ratio, and hopefully to address the demographic risks faced by distributive pension systems,» the authors conclude.