have been as good as those driven by a set of rather simple portfolio benchmarks.<sup>6</sup> A comparison of the performance of the international portfolio of the pension funds against simple portfolio benchmarks may help to explain this point.

The investment strategies for international equity investments followed by the Chilean pension funds between 2007 and 2014 have not been able to add any significant value to the alternative of investing in simple international equity indices. We benchmarked the portfolios of the pension funds against an equity index of a developed economy (S&P500) and an equity index of emerging markets (MSCI Emerging Markets). We tested the existence of _Alpha_ (returns in excess of market returns) and, not surprisingly, we found that in most of the cases they were negative, as shown in Table 1. Using monthly data, we tested the _Alpha_ against portfolios that maintain the weights constant for the whole period between developed markets and emerging markets equity indices (50/50; 60/40; and 70/30), and also against a portfolio that uses the same weight as the pension funds at each moment in time. With the exception for the case of 50/50 in portfolio A and another one where the indicator is zero, the rest of the _Alphas_ were negative.<sup>7</sup>

**Table 1. Chile: Alphas of pension fund investments in international equity**

<u>(against S&P500 and MSCI Emerging Markets indices)</u>

||Fund A|Fund B|Fund C|Fund D|Fund E|
|---|---|---|---|---|---|
|50% S&P500 / 50% MSCI EM|0.4%|-0.6%|-1.8%|-3.7%|2.8%|
|Actual Weights<sup>1</sup>S&P500 / MSCI EM|-0.6%|-1.7%|-3.0%|-5.3%|1.8%|
|60% S&P500 / 40% MSCI EM|0.0%|-1.0%|-2.2%|-4.1%|2.3%|
|70% S&P 500 / 30% MSCI EM|-0.4%|-1.4%|-2.5%|-4.5%|1.8%|

Source: The authors’ calculations based on information from the Superintendencia de Pensiones and Bloomberg.

The inefficiency of the international investment strategies followed by the pension funds can be explained in several ways. First, the strategies are unable to outperform simple well-diversified portfolio indices. Second, the pension funds have been relying on inefficient TAA in conducting their investment strategies, which has resulted in higher fees paid to asset managers. Third, PFMCs have managed the pension portfolios with a different level of risk compared with those of well-diversified portfolios.<sup>8</sup> These results confirm the importance of adopting SAA as a way of guiding the investments of pension funds. Adopting SAA implies establishing long-term portfolio benchmarks with a clear strategic vision about optimizing future pensions of individuals. The portfolio benchmark is expected to guide the relative allocation of the different asset classes along the lifecycle of individuals. While

> 6 As of September 2014, international equity portfolio of the pension funds is channeled through investments in 96 mutual funds, 41 indices, 33 domestic funds invested abroad, two ADRs, one share of a foreign company and one foreign investment fund.

> 7 Fund E is excluded because international investments are insignificant.

> 8 The tracking error of the pension portfolios against these international equity indices tends to be high, which means that the risk level is significantly different from those of these well-diversified portfolios. For example, the equity exposure to Latin America is higher than the exposure in the MSCI Emerging Market Index, which is riskier from the perspective of the future pensions of individuals.

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