The OECD has called on global policymakers to avoid restrictive regulatory frameworks that could lead to overly conservative investment strategies in defined contribution pension schemes, as a new study from the organisation found that equity exposure usually brings better retirement income outcomes.
The study, which was a part of the 2024 OECD Pensions Outlook report, found that “higher equity investment usually brings higher average performance when comparing defined contribution (DC) pension funds that have different levels of equity exposure within countries or within pension entities”.
The analysis also shows that a vast majority of member cohorts (at least 80 per cent) across 19 different OECD countries would have more savings in retirement, had they invested at least partly in a mix of domestic and foreign equities instead of only investing in domestic fixed income securities, over a 40-year period.
Australian pension funds do not have a regulatory limit on equity investment, but among jurisdictions with one, the limit ranges from 0 per cent, where equity investment is not allowed at all, to 80 per cent.
“Pension regulators should avoid setting frameworks that lead to default investment strategies that are too conservative as equity investment tends to bring better retirement income outcomes,” the report said.
“Countries should ensure that their investment regulations are not constraining equity investment in a way that could reduce risk-adjusted returns.
“Similarly, attention should be given to investment limits affecting foreign investment and alternative investments, such as infrastructure and real estate, as they play a role in diversification.”
Over the past 20 years, equity investment has been steadily increasing in DC funds across jurisdictions. Among 23 OECD countries and 15 non-OECD jurisdictions, Australian pension funds have the tenth highest exposure to public and private equity as a percentage of total assets.
At the end of 2022, total equity exposure (public and private) represented more than 40 per cent of total investment in 13 out of 38 jurisdictions analysed, while only seven jurisdictions had less than 20 per cent invested in total equities.
However, the report acknowledged that high equity investment has several caveats. For one, its analysis found that pension schemes with higher equity exposures have usually delivered more volatile annual investment returns over the past seven to 21 years.
Secondly, higher equity exposure only leads to a better retirement outcome when people save for retirement over long periods, as the analysis showed that people who would have saved for 40 years are better off than those who would have saved for 20 years. This is an important issue especially in countries with voluntary pension contributions where people may start saving later in life.
Lastly, higher equity exposures also make pension benefits sensitive to equity market downturns occurring when people are close to retirement – but the report pointed out that lifecycle strategies can effectively mitigate some of these risks.
The report also suggested that policymakers encourage the development of innovative lifecycle options, such as by tailoring a glide path to adapt to the needs of individuals.
“For example, the reduction in equity exposure may start in the last 10 years before retirement when people are planning to take an annuity, but if they take regular drawdowns and remain invested during the payout phase, the reduction in equity exposure may be smoother and continue into the payout phase as the investment horizon is longer,” it said.
