Pension Markets in Focus 2023

1. Elevated inflation and rising interest rates led to widespread investment losses

Higher inflation and interest rates characterise the year 2022. The rise in interest rates led to widespread investment losses for asset-backed pension systems in nominal terms. After accounting for high inflation, losses were much larger in real terms. Investment gains in the previous years helped to compensate for the losses over the longer term.

This section examines the impact of elevated inflation and rising interest rates on the rates of return of asset-backed pension systems and their asset allocation. Asset-backed pension systems cover both pension plans that individuals access via their employer or a financial institution and where they accumulate assets or rights (hereafter ‘pension plans’) and public reserves that social security institutions or governments build up to support public unfunded or pay-as-you-go systems, and which are generally held separately in ring-fenced funds (hereafter ‘public pension reserve funds’).1

1.1. Asset-backed pension systems suffered investment losses on several asset classes simultaneously

Assets earmarked for retirement are mainly invested in bonds and equities. These two instruments accounted for more than 70% of the investments of pension plans and close to 90% for public pension reserve funds on average at end-2021, with an asset mix varying across jurisdictions (Figure ‎1.1). Those favouring bonds, in particular government bonds, may do so due to the perceived income stability and the lower risk level of these instruments compared to others, a lack of other investment opportunities domestically, the existence of guarantees or a recent introduction of pension plans.2 In some cases, regulation may also require a minimum proportion of assets to be invested in bonds (e.g. those with a multi-fund structure with floors (OECD, 2023[1])) or all in bonds (e.g. the US Old-Age and Survivors Insurance Trust Fund that is required by law to invest fully in non-marketable US government bonds). Those with higher allocations to equities may have been seeking higher returns by taking more risks, such as the Japan’s Government Pension Investment Fund and Korea’s National Pension Fund.

Figure ‎1.1. Allocation of assets earmarked for retirement in selected asset classes and investment vehicles, at end-2021

As a percentage of total investment

Note: For more details, please see the methodological notes in ‎Annex C.

* This designation is without prejudice to positions on status, and is in line with United Nations Security Council Resolution 1244/99 and the Advisory Opinion of the International Court of Justice on Kosovo’s declaration of independence.

Source: OECD Global Pension Statistics and other sources.

Statlink

Asset-backed pension systems were hit by the simultaneous fall in bond and equity prices in 2022. The rise in interest rates lowered the value of bonds in pension investment portfolios. At the same time, equity markets also fell globally, with prices down by 19% for S&P500, by 9% for Nikkei 225 and by 12% for DAX at end-2022 compared to end-2021 for example.3 Pension plans and public pension reserve funds incurred losses both on their bond and equity holdings, resulting in overall negative rates of return in nominal terms in many jurisdictions in 2022 (Figure ‎1.2).

Figure ‎1.2. Nominal and real investment rates of return (IRR) of asset-backed pension systems, Dec 2021 - Dec 2022

In per cent

Note: For more details, please see the methodological notes in ‎Annex C.

Source: OECD Global Pension Statistics and other sources.

Statlink

In addition to equity and bond portfolios, losses on other financial instruments also contributed to negative nominal returns. In a context of rising interest rates, pension plans in the Netherlands and the United Kingdom suffered losses on their interest-rate derivatives held to hedge against the risk of declining interest rates. Dutch pension funds also recorded losses on their real estate investments.4 These losses, combined with those on bonds and equities, led pension plans in the Netherlands and the United Kingdom to record the lowest nominal returns among all reporting jurisdictions (-21.1% and -18.5% respectively).

Meanwhile, pension plans in some countries benefitted from the changes in foreign exchange rates. The rapid rise in interest rates in the United States made US dollars attractive to investors, who sold other currencies to purchase them, which strengthened the US dollar against these other currencies (Alderman, Camp and Mandiak, 2023[2]). Some pension plans achieved foreign exchange gains on their investments abroad, as the domestic currency depreciated against the US dollar (e.g. the Netherlands). These gains offset some of the investment losses and even resulted in positive investment rates of return in some countries (e.g. Zambia).

The method of valuing assets can influence the investment performance results. For instance, the rise in interest rates in domestic government bonds had little effect on the value of bond holdings when pension funds value assets following an amortised cost method based on effective interest rates (e.g. Albania). Similarly, since early 2022, the Demographic Reserve Fund in Poland has also been valuing its debt securities according to the adjusted purchase price determined based on the effective interest rate, as the reserve fund intends to hold its debt securities until maturity. This valuation method does not capture the decline in the price of debt instruments following interest rate hikes in the performance results.

Elevated inflation turned nominal investment gains into real losses and made nominal losses much larger in real terms. Real rates of return were negative for pension plans in all OECD countries and nearly all reporting non-OECD jurisdictions. Real rates of return were the lowest in some of the countries where inflation surged the most (e.g. Hungary, Latvia and Lithuania with annual rates over 20% in December 2022 (OECD, 2023[3]) among OECD countries, and Ghana, Suriname and Zimbabwe outside the OECD, where the consumer price index rose by 52%, 55% and 111% respectively). Most public pension reserve funds also experienced real losses in 2022. Real rates of return were positive in 2022 in just a couple of African countries (Lesotho, Zambia) and the Maldives, where inflation did not offset nominal investment gains.5

Strong investment gains in the previous years helped to compensate for the losses in 2022 in many jurisdictions. Pension plans reached an average annual return above inflation in 21 out of 55 reporting jurisdictions (i.e. in 38% of the reporting jurisdictions) over the last 5 years, 33 out of 44 (i.e. 75%) over the last 10 years, 24 out 34 (i.e. 71%) over the last 15 years, and 15 out of 19 (i.e. 79%) over the last 20 years (Table ‎1.1). The investment performance of public pension reserve funds was also positive in real terms over the last 15 or 20 years in all those for which data are available.

Table ‎1.1. Geometric average annual real investment rates over the last 5, 10, 15 and 20 years

In per cent

Note: For more details, please see the methodological notes in ‎Annex C.

Source: OECD Global Pension Statistics and other sources.

Statlink

Countries where pension plans failed to generate a positive cumulative return above inflation over the past 20-year period invested conservatively. Bulgaria, Czechia, Estonia and Latvia all have negative average annual real rates of return and high bond proportions in their pension investment portfolios (Figure ‎1.1).6

1.2. Elevated inflation and rising interest rates may have spurred a change in asset allocation

The proportion of pension assets invested in equities dropped in most countries in 2022 (Figure ‎1.3). This could be the result of the fall in equity prices, but also of a decision to move away from equities in a global context of uncertainty with high inflation, volatility in equity markets and fears of recession.7 This fall in equity holdings occurred even in some countries that changed their default investment strategies to encourage more risk-taking to achieve higher long-term returns (e.g. Croatia, Lithuania and New Zealand).8 Yet some other countries that also encouraged more risk taking during the accumulation phase increased their equity allocations despite the decline in equity valuations, such as Estonia.9

Figure ‎1.3. Variation in the proportion of pension assets invested in bonds and equities between end-2021 and end-2022 in selected OECD and non-OECD jurisdictions

In percentage points

Note: For more details, please see the methodological notes in ‎Annex C.

Source: OECD Global Pension Statistics.

Statlink

Bonds may have benefitted to some extent from this shift away from equities. Although their prices also declined in 2022, the proportion of bond holdings in the portfolios increased by just over 1 pp for pension plans while remaining stable for public pension reserve funds on average, contrasting with previous years when investors were moving away from bonds and searching for instruments with higher return potential (including equities) as interest rates were low and falling (OECD, 2023[4]). The recent surge in interest rates may have triggered a renewed interest in bonds, already visible in some countries (e.g. +4 pp in North Macedonia), given the prospects of higher returns from the newly issued bonds and the relative safety of the income they generate when held to maturity.

Higher allocations to bonds also came from a reduction in cash holdings. For example, the pension agency in Georgia started diversifying the allocation of the assets in mandatory pension plans in 2022 and diverted most of its cash holdings (-34.7 pp) to bonds (+27.4 pp). Similarly, pension plans in Greece reduced their cash holdings by 10.1 pp and increased their bond exposure by +9.4 pp as the yield spread between cash and bonds was broadening.

At the same time, in several reporting jurisdictions pension plans increased their cash holdings, mainly as a result of pension reforms rather than market developments.10 In the Slovak Republic, pension funds needed liquidity (+ 8 pp to cash) to carry out the transfer of assets from the bond funds to the new default life cycle pension funds introduced in 2023. In Peru, pension funds also increased their cash holdings (+1.5 pp) to comply with their obligations, should members request early access to their savings as the Congress allowed six times between 2020 and 2022. In the United Kingdom, market developments with the sharp rise in gilt yield in September 2022 led pension plans that use liability-driven investing (LDI) strategies to hedge their liabilities against a decline in interest rates to sell assets to get cash. However, the overall increase in cash holdings of all pension funds was rather limited overall (+0.8 pp at end-2022) probably as a result of the intervention of the Bank of England to cool the gilt market.11 The increase in cash holdings of pension plans was more substantial in the Netherlands (e.g. + 1.3 pp) to meet margin calls from interest-rate derivatives. However, pension funds had margin call related activities (such as derivatives and repurchase agreements) in less than half of IOPS reporting Members (14 out of 37 reporting jurisdictions) and faced no significant liquidity risk arising from margin calls according to their pension supervisors (Oh and Stańko, 2023[5]).

The proportion of assets invested in other instruments than equities, bonds and cash (hereafter ‘alternative investments') also increased for pension plans and public pension reserve funds in most reporting jurisdictions in 2022.12 Some of these alternative investments generated positive investment income (e.g. private equity in Colombia), while others (e.g. direct real estate in the Netherlands and Switzerland) recorded lower losses than traditional instruments and other alternative instruments that are more sensitive to market fluctuations (e.g. securitised debt).13 While alternative investments benefitted from the search for yield during the period of low and falling interest rates, some may continue to attract asset managers for their capacity to hedge against inflation (such as in Asia).14 Some jurisdictions have also been promoting alternative investments by pension plans by removing or lifting barriers in investment regulations (e.g. Colombia).15 Several public pension reserve funds also increased their alternative investments, with the largest rise for the New Zealand Superannuation Fund (by 9 pp between June 2021 and June 2022) driven by an increased allocation to infrastructure, property and other alternatives.16

Notes

← 1.  See ‎Annex A for a more detailed description of asset-backed pension systems and their features.

← 2.  The lack of depth and breadth of local capital markets may have contributed to the large allocation of assets to public debt in some Latin American countries (e.g. Costa Rica, Dominican Republic and Uruguay) (Mesa-Lago, 2020[14]). Pension plans introduced earlier (e.g. Chile) may have a more diversified strategy than others in Latin America (FIAP, 2018[15]).

← 3.  Market Data (wsj.com)

← 4.  Pension funds suffer losses on real estate (dnb.nl)

← 5.  The Maldives benefitted from the recovery of the domestic economy following the rebound of tourism in 2022.

← 6.  In Estonia, the lifting of ceiling on equities has led to a surge in the proportion of assets invested in equities (from 34% in 2018 to 64% in 2022) and a decline in the proportion invested in bonds (from 62% in 2018 to 29% in 2022). This recent move to more risky investment has not yet led to positive long-term returns due to the downturn in equity markets in 2022 and the lack of a sufficient number of more buoyant years.

← 7.  Some of these equity investments were carried out abroad, which may also explain some of the decline in foreign investments (e.g. Chile). See the statistical annex for the evolution of foreign investments (‎Annex B).

← 8.  Croatia and New Zealand changed their default investment strategy to a less conservative one in 2019 and 2021 respectively. Lithuania established life-cycle funds as the default option in 2019.

← 9.  Estonia raised the limit to invest in equities from 75% to 100% in 2019 for non-conservative funds.

← 10.  With respect to public pension reserve funds in the OECD, cash holdings declined in half of them.

← 11.  The limited movement in cash may also be related to a deleveraging strategy from UK pension funds in the last quarter of 2022, where more liquid assets were likely used to pay down relating to repurchase agreements (Office for National Statistics, 2023[17]).

← 12.  The proportion of assets in other investments than equities, bonds, and cash (and collective investment schemes when the look-through is not available) increased in 30 out of 35 reporting OECD countries, 27 out of 38 reporting non-OECD jurisdictions and 12 out of 20 selected OECD public pension reserve funds. See statistical annex for the evolution of the asset allocation of pension plans over the years (‎Annex B).

← 13.  Pension funds suffer losses on real estate (dnb.nl) and Compenswiss holds strategy as first pillar reform gives room for illiquid investments | News | IPE

← 14.  Asia’s Pension Funds Allocate Further to Alternatives | Cerulli

← 15.  Colombia issued a Decree in 2022 removing all the limits on alternative investments that were set before and requiring a minimum investment in private equity or private debt.

← 16.  NZ Super Fund - Annual Report