The Chinese Pension System
February 12, 2025
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Traditionally, pension funds were averse to equity investments. However, over the years, pension funds have been steadily pouring money into pension funds. This has been facilitated by the lower interest rates offered on fixed income securities as well as the rise in the value of stocks and other risky assets.
Nowadays, most experts believe that it is beneficial for pension funds to continue to invest in equity.
However, there is still a small faction of experts who believe that investing in stocks is against the interest of pensioners. In this article, we will present the case against investing in stocks.
Therefore, if the stock market were to go down, the pensioners risk losing their jobs as well as their assets accrued within the pension funds. This is against the principles of diversifying risks and hence pension funds must avoid making investments in equity.
However, most of the debt instruments that the pension funds invest in are vetted first. Hence, they are not likely to default and can be considered to be risk-free particularly if they have been issued by the government or government agencies.
In a way, stock markets enable the transfer of risks across many years. This is generally not a problem for an individual investor. However, this can be a problem for a pension fund. This is because, in a pension fund, the people who reap the benefits may not be the same as the people who bear the risks.
It is quite possible that a retiree may be able to obtain a higher value because they have to bear no risk but can gain from the rewards.
At the same time, the young pensioner may end up bearing the risk for a long time without even being compensated for the same. This means that equities end up creating intragenerational transfers of risk which are involuntary. This creates a problem for pension funds as they end up favoring one set of retirees over the others.
Hence, many experts believe that pension funds are very tax-efficient when it comes to managing debt instruments. As a result, if a person wants to have a portfolio that contains both debts as well as equity, they should use pension funds to hold the debt portion of their investment.
At the same time, they can use their equity investments in their personal account. Using pension funds to hold equities is just a waste of the tax efficiency which is built into their structure.
However, when it comes to equities, the pension funds have to keep churning their portfolios. This is because the performance of equities is unpredictable and the fund managers need to make constant adjustments to their portfolios.
Also, such a portfolio cannot be passively managed since an active fund manager is required in order to maintain this portfolio. The end result is that the transaction charges of equity-based portfolios are much higher as compared to debt-based pension portfolios. The compounding effect of many years makes this difference even more significant.
It is possible that the equity markets may collapse 20% to 30% in any given year. For a pensioner, the 20% to 30% fall can be catastrophic since they will not get a chance to recover from the same.
Hence, it can be said that there are several reasons that pension funds should not be allowed to invest in equities. If any person does believe that these reasons are applicable to them, they can choose not to invest in equities as per the defined contribution pension plan structure.
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