goal of delivering adequate retirement income in mind. The purpose of the paper is to help pension system regulators think about how they may incentivize funds operating in their jurisdiction to adopt such an approach. This paper does not pretend to have all the implementation answers, but the adoption of the philosophy can go a long way to helping ensure that the suite of regulatory measures is better designed towards achieving secure, adequate income in retirement, which is the ultimate goal of all our pension systems.

5. After analyzing the problem of short-termism in Section II, the paper goes on to consider how such long-term, outcome focused benchmarks can be created in Section III, whilst Section IV provides some examples of leading pension funds around the world which have adopted such an approach. Section V offers some conclusions.

# **II. Short-termism of Pension Fund Providers and Regulatory Misincentives**

6. The main goal of any pension system is to ensure that members receive an adequate pension income when they retire. While traditional defined benefit (DB) pension plans set out what that pension income will be in advance and then strive to deliver it, the growing number of defined contribution (DC) plans accumulate a sum of assets which can then be turned into a pension income on retirement. However, the amount of this retirement income is not predetermined (and indeed in many countries that introduced DC private pillars, pay-out phases will become important only in many years to come or/and the legal framework for setting up the pay-out phase is still in preparation). This frequently leads to a focus by not only most pension providers, but also regulators and pension plan members themselves on the short-term accumulation of pension assets rather than the longer-term goal of securing an adequate retirement income. The risk of not achieving this goal can be termed ‘pension risk’.

7. Pension investment regulation in most countries currently serves to reinforce this focus on the short-term delivery of investment returns rather than the long-term generation of a pension income. Investment risk is generally controlled via limits on the amount of a portfolio which can be invested in certain assets.<sup>6</sup> Though strict investment restrictions may achieve the basic goal of safeguarding retirement savings, these rules do not come without costs. Vitas (1996) argues that portfolio restrictions may be required in the initial stages of pension reform when there is a lack of qualified asset managers and capital markets lack strength and capacity, as asset allocation limits are a way of isolating pension fund assets from agency and systemic risks in capital markets – though this assumes that pensions are restricted to investing in domestic assets and does not consider the fact that international diversification in the face of an undeveloped domestic capital market could be optimal from a risk/return perspective (taking into account foreign exchange risk).

8. However these investment restrictions create distortions in asset management, limit opportunities for diversification and can hamper investment performance.<sup>7</sup> Pension funds, particularly in developing economies, often end up controlling a disproportionate share of some of the markets for those securities in which they are allowed to invest – i.e. they cannot trade in these markets

> 6 Details of investment restrictions around the world can be found in the regular OECD survey: http://www.oecd.org/finance/private-pensions/annualsurveyofinvestmentregulationofpensionfunds.htm

> 7 (Srinivas and Yermo 1999). See also Del Guercio (1996)

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