PensionReforms' summary and comments
Governments everywhere either directly run pension schemes or significantly affect what they do on a day-to-day basis.  Then there are the compulsory Tier 2 schemes that usually have intricately detailed rules about what they (and their members) can and cannot do.

Generally, government intervention in the investment processes of pension schemes is not a great idea.  They often do a poor job.  They should bring scale and reduced (or no) marketing costs to that role:
"But this important advantage has in most countries been dissipated by poor investment performance.  The latter has been attributed to a weak governance structure, lack of independence from government interference, and a low level of transparency and public accountability."

The poor investment returns are particularly debilitating over the long term:
"With some notable exceptions, public pension funds were historically poorly managed in most countries.  They were often forced to invest in government bonds and housing loans at low nominal interest rates, while investments in foreign assets were prohibited.  In countries that suffered from high inflation, real investment returns were negative, while even in countries where nominal interest rates exceeded inflation, the returns on public pension reserves were well below equity market returns and well below the returns achieved by private pension funds."

The report labels the past performance of a relatively long list of public schemes as "mediocre to disastrous".

The report looks at four relatively new public pension schemes (from Norway, Canada, Ireland and New Zealand) to see what structures have been incorporated to limit the risks that such large pools of capital in the public domain might bring with them.  Each of the schemes had a slightly different genesis - Norway's started in 1990 as the Government Petroleum Fund (since 2006, the 'Government Pension Fund') and was set up to invest oil revenues.  Although all decisions are made by the Ministry of Finance (with no 'arms-length' directors), it "... is required to operate with a very high level of transparency and accountability."

"The Canada Pension Plan Investment Board (CPPIB) was created in 1997 as part of a package of measures that aimed to prevent the insolvency of the CPP [the Tier 2 'Canada Pension Plan'] in 2015.  A major change was the acceleration in the projected increase in the contribution rate from 6 percent in 1997 to 9.9 percent in 2002.  This was expected to generate significant reserves and the CPPIB was established to ensure their efficient management.  The CPPIB objective is to accumulate reserves equal to 20 percent or more of the actuarial pension liabilities of the CPP."

The Irish National Pensions Reserve Fund (NPRF) started in 2000 with the proceeds of the Telecom Eireann privatisation.  It aims to build a fund that will be equivalent to "...about one-third of the cost of public pensions (social welfare and public service) between 2025 and 2055 and possibly beyond."

The New Zealand Superannuation Fund (NZSF) started in 2002 and allowed the government to set aside budget surpluses against the future cost of New Zealand Superannuation, the universal, Tier 1 state pension.  It introduced the concept of a "smoothed pay-as-you-go" way of paying for the public pension.

"The paper discusses the safeguards that have been introduced to ensure [the schemes'] independence and their insulation from political pressures. It also reviews their performance and their evolving investment strategies."

The report suggests that, in the cases of Ireland, New Zealand and Norway, with their low levels of public debt "the authorities did not face a difficult policy dilemma in deciding to create a new public pension fund.  Creating a fund and investing in global assets was likely to earn a higher rate of return than the cost of public debt."  (PensionReforms notes that things have changed a bit since this 2008 report.)

The report looks at the schemes' governance structures and investment management processes.  In summary, the report approves of arms-length arrangements that leave the schemes themselves to decide where the money should be invested.

"All four funds started with the romantic idea of operating as 'managers of managers' and focusing on external passive management but their strategies have progressively evolved to embrace internal active management and significant investments in alternative asset classes.  The paper draws lessons for other countries that wish to modernize their public pension funds."

PensionReforms notes the report's explanation as to whether public debt held by the more 'independent' public schemes makes those securities 'real' or 'notional'.  PensionReforms thinks the distinction is unnecessary.  There is in substance little difference between an unfunded PAYG system and, say, the US Social Security system that has a so-called 'Trust Fund'.  Whether or not the public scheme can sell the public securities is also not a distinction of significance.  A scheme that has all its assets (or any of them) invested in debt issued by the government itself has created a money-go-round that offers little additional security to the pension scheme's beneficiaries (compared with a simple PAYG 'promise').  Such securities are akin to the 'implicit debt' calculations preferred by some commentators - see here for example - but they are of no real substance.

PensionReforms notes another issue with public schemes that the report did not cover.  All governments have public debt (outside any consideration of the pension scheme itself).  Even if the public pension scheme buys 'real' investments at arms-length (such as shares, corporate bonds or property) then the scheme is effectively 100% leveraged when looking at the government's balance sheet as a whole in a 'total accounting context'.  Rather than putting public money into the pension scheme, the government has the option of reducing debt.  So, when the public scheme's investment returns are examined, it is only the excess returns over the government's costs of debt that count (what PensionReforms calls the 'hurdle rate').  To the extent that the public pension scheme misses the 'hurdle rate', the presence of the scheme means that the government's net worth has been diminished by the scheme's presence.

The most recent annual returns illustrate the risks the four governments have run with public money.  For 2008, the losses were: Ireland -30.4% New Zealand -26.2% Norway about -24% (global part -23.3%; domestic part -25.1%) and Canada -18.6%.  It is relatively easy to reduce the significance of these as the returns that might be expected in exceptional times; also to point to the 2009 recovery as evidence that things are returning to normal.  Adding the costs of leverage to these returns should, however, give pause for thought.

Whether pension systems are public or private; pre-funded (wholly or partly) or PAYG is less important than the strength of the economy that has the obligation to convert future pension claims to consumption (the ultimate purpose of any retirement income system).  PensionReforms is unconvinced that the four public schemes profiled in the report have added any significant security to the pension promises made by the governments involved.  On the other hand, they may have diminished the ability of governments of the day to spend budget surpluses that have since turned out to be transitory.  That being the case, it now seems time to draw down on the investments rather than raise new debt.  (File size 268 KB; 68 pp) 364