For hybrid plans in Europe, nominal guarantees on premiums are usually required. Yet for young participants, these guarantees can be reduced – as long-term investors they have little need for nominal guarantees. This reduction gives way to more flexible and better performing funds and produces more sustainable hybrid plans. Nominal guarantees can be important for older participants, because they can be considered a proxy for real ones over the short term. The system should be flexible enough to accommodate different indexation policies in line with the life-cycle approach, in which the risk and reward change with age.

Not the regulators

However, the effort should not lie with regulators alone – practices need to evolve, as there is empirical evidence that pension funds behave sub-optimally. Even though pension funds have been praised for their ability to diversify, empirical evidence suggests that they do not fully use their ability to diversify and invest in illiquid assets. They often have a strong home bias, which is contrary to running the risk of insufficiently protecting the purchasing power of retirees in maturing economies.

The demographic theme should also be taken into account as it is an important driver for growth. It can be expected that in the future the production of future retirement goods will shift towards countries with a growing workforce. Their internal organisation and resources are certainly important, with infrastructure, education and democracy often associated with economic growth.

Lastly, the short-term behaviour shared by many pension funds that are locked into minimum funding ratios and nominal strategies can be avoided through adequate definition of the investment strategy.

Samuel Sender is an applied research manager at EDHEC-Risk Institute