Why is there value in investing pension monies globally?
Risk spreading is an essential part of pension fund management. In Estonia, it is only possible to offer pension funds whose investment strategy ensures adequate diversification of risks.
A majority of pension funds have gone beyond the formal requirements applicable to the diversification of risks by investing the money from pension funds in many different funds, instead of investing in selected individual shares. Thus, the likelihood of ensuring the security of pension assets is higher.
Diversified investments help avoid fluctuations in the value of assets
“Diversification is the only free lunch” was said back in 1952 by Harry Markowitz, recipient of the Nobel Prize in Economics and author of the Modern Portfolio Theory. According to his theory, diversification of risks may increase the return on the portfolio without price fluctuations, i.e., without increasing the risk. The prices of different assets do not behave similarly: therefore the rate of return of the portfolio evolves as the average return on all investments; however, the portfolio’s risk is lower than the average risk of individual investments. Hence, fund managers endeavour to put together portfolios in which the risks are maximally diversified at the desired level of return. This, in turn, fuels the drive to seek out global investment opportunities.
Today there is only a small community of investors who would take the concentration risk involved in investing in just a few companies. In order that investors could make comparisons with other funds and the general market perspective, market indices were needed which, at first, were country-specific. This soon made fund investments increasingly similar to index compositions, i.e., the movement was towards greater diversification. As global financial freedom evolved and the portfolio theory triumphed, the first global stock index was created in 1969.
SEB invests pension assets mainly in global funds
The core of SEB’s pension funds consist of global investments where our selected investment funds (actively managed funds) attempt to outperform the return or maintain it with costs that are as low as possible (index funds). Depending on the perspectives of different regions, sectors or asset classes, globally invested funds are complemented with some interesting focal points, such as investments in Nordic equity funds or Baltic risk capital and bonds. However, these investments too must meet the threshold established by the global set of investments, i.e., the market index.
Moreover, it does not make sense to accumulate the risks of the local economy as the setbacks may be serious, such as loss of employment or a drop in property prices. Diversification helps limit the impact of a local economic downturn on pension funds.
Vahur Madisson
Fund manager
