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Impact Investing

IPE special report May 2018

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Pension funds a 'stabilising force' during financial crises – academics

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Dutch pension experts have concluded that pension funds can have a stabilising effect on markets during financial crises.

Roel Beetsma and Siert Vos, in an article published on the Centre for Economic and Policy Research’s website, attribute the stabilising effect to pension funds’ tendency to rebalance their investment portfolios frequently.

“If a shock causes their equity or fixed income allocation to drop below a strategic level, pension funds start topping up,” they write.

“This, in turn, triggers additional demand for the asset class, which could help breaking a vicious circle of falling prices.”

Beetsma, a professor of pensions economics at Amsterdam University (UvA), and Vos, a researcher at UvA, suggest that, within one month, pension funds rebalance 20% of changes in equity holdings caused by market movements.

They estimate the corresponding figure for a changed fixed income weighting at 25%.

The researchers point out that the recent stress tests conducted by European supervisor EIOPA confirmed that pension funds help cushion the drop in markets in 2008-09.

The stress-test report cites Dutch pension funds buying equity in 2008 to rebalance their portfolios towards their positions at the end of 2007.

At the time, pension funds in Austria, Spain and Slovenia divested equity, while German schemes sought protection in derivatives, which forced divestment, according to EIOPA.

The regulator concluded, however, that pension funds’ overall impact had been anti-cyclical, citing differences in local investment strategies to the differing responses in the various countries.

According to Beetsma and Vos, supervisors’ increasing tendency to issue similar rules for different market players carries the risk that all parties respond to market shocks in a similar way, which may increase the impact of an event.

The researchers also cite the fact pension funds rarely borrow as a reason why they pose little systemic risk.

“Because schemes invest for the long term, they could be technically insolvent, but they can’t go bust,” they add.

“Insolvency could be tackled through an increase of contributions, additional payments by a scheme’s sponsor, a reduction of indexation or rights cuts.

“This way, pension funds can recover in an orderly fashion and avoid a much more disruptive bankruptcy process.”

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