Pension Fund Investment and Regulation - a macro-study

Pension fund assets have been accumulated rapidly during past decades, and there are signs that such trend will continue. An immediate problem arising from the rapid accumulation of such a large volume of assets across countries is how to invest them. Pension funds differ from other institutional investors, e.g. mutual funds, in that their investment horizons are relatively long, typically 30-40 years. In addition, they are pooled assets to support people’s retirement lives. Therefore, national governments are more worried about their investment performance, because otherwise, the shortfalls will have to be met by the nation state (Clark and Hu 2005a). In this paper, we seek to address this issue from the macro perspective. By using a unique dataset covering 38 countries (16 EMEs and 22 OECD) and based on the mean-variance optimisation approach, first we find a negative impact of international portfolio investment restrictions on pension fund returns and risk, and this issue is particularly serious for EMEs. Second, there is evidence that if higher portfolio returns are wanted, higher proportion should be invested in equities, of which domestic equities gains more weights gradually. Third, our results show that pension funds in OECD countries should value the diversification benefit arising from the property investment (Booth 2002). Fourth, compared with EMEs pension funds, the optimal share of foreign assets in the portfolio of OECD pension funds is small, which might be due to the differential in asset returns between OECD countries and EMEs (Davis 2005a). 1 Yu-Wei Hu is a doctoral student at Brunel University (email: [email protected]). The paper is part of my PhD project. I would like to particularly thank my PhD supervisor, Prof. E Philip Davis for his helpful suggestions and comments. In addition, the paper benefited from conversations with Prof Gordon Clark (Oxford), and Kevin Rush (CSFB, London). Any errors are of my exclusive responsibility.