# 4. Conclusions

The paper documents a significant increase in long-term asset allocation over time, but that this is hampered by pension fund managers having to manage redemption risk. Greater diversification of DC pension funds in the eight LAC and CEE countries can be seen over time – whether into a broader range of domestic assets, or overseas investments. However, the paper shows that excessive switching between fund providers and portfolios can curtail the ability of pension fund to invest long-term. The analysis of the Colombian and Chilean data suggest that funds hold both more liquid and shorter-term assets in order to cope with switching demands – in Chile’s case between private pension providers and for Colombia between the public and private system. Both factors could impede exposure to longer-term, less liquid investments (such as infrastructure related investments) which policy makers are increasingly looking to pension funds to finance – or indeed mean that these investments will have to be structured with these liquidity needs in mind.

Holdings of short-term or liquid assets may be required where switching levels are high, but in other cases could be more ‘precautionary’. In some cases, (e.g. Chile, Mexico), the holding of large amounts of short-term or liquid assets in the portfolios seems necessary due to the sometimes high levels of switching, particularly between funds but also between providers. In other case (e.g. Romania) the large holdings of these types of assets maybe more precautionary as the actual outflows – including those driven by switching – are relatively limited. Whether some form of ‘liquidity reserve’ could be established to prevent such precautionary holdings is an idea which could be discussed, with lessons possibly to be drawn from other financial sectors and products (e.g. repos, UK ‘buy-out’ market).<sup>27</sup> Sizeable outflows from switching produce several negative outcomes. For individuals changing provider, portfolio, or even pension system, as is the case of Colombia (fortunately uniquely for now), the evidence suggests that most obtain lower returns and reduce their potential retirement income. Beyond the negative effects on their own pension accounts, members who switch often also impose a negative externality to other fund members. Since fund managers have to rebalance their portfolio to accommodate larger outflows by increasing their holdings in short-term assets and in those that are more liquid, pension funds end up with lower than expected returns. Furthermore, given the size of these funds relative to their domestic markets, flow management might lessen the ability of pension funds to provide long-term finance. Whether the benefits of competition, marketing, and lenient switching policies outweigh the costs of a potentially weaker long-term performance is outside the scope of this paper and needs to be investigated further. Alternative industry structures (such as those using blind accounts) again need further consideration.

Changes in switching regulation (making such changes more administratively difficult) and marketing controls and incentives can reduce this type of switching considerably. This in turn allows pension funds to hold a greater percentage of longer-term while at the same time allowing for flexibility on the member’s choice.

27Repos are ‘sale and repurchase agreements’ whereby one party agrees to sell a security at an agreed price to another party at time A and agrees to repurchase the same security also at an already pre-agreed (higher) price at later time B (the difference in the two prices being known as the ‘repo rate’ which can be interpreted as the interest rate over the period). In some pension fund insurance ‘buy-outs,’ the costs are reduced by what are called ‘in-specie’ transfers whereby effectively the pension fund and insurance company swap title for the assets that will remain in force backing the annuity product – so that the only assets actually sold are those that will not feature in the on-going portfolio (see Lane Clark Peacock 2015).

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