You really want to read about pension funds, don’t you?

Pension fund talk really gets the blood flowing, doesn’t it? Well, we’re going to try our wonky best.

India’s Pension Fund Regulatory and Development Authority (PFRDA) is the government body responsible for regulating the country’s pension sector. In response to a proposal for new pension system that features defined contribution plans and professional financial funds, the PFRDA recently published a report on recommendations for this new plan. (The paper is no longer online, so special thanks to Amol Agrawal for sending it our way. We’ll post it if it comes back online.)

The paper’s discussion of the default rule is an interesting window into how thinking about default rules for investments has changed over the past decade, and how policymakers in different countries may end up addressing this issue.

Nudge includes a chapter on the Swedish experience with personal retirement plans earlier in the decade. Swedish policymakers selected a single fund with a mix of Swedish equities, global equities, bonds and cash as a default fund. This decision was made before the recent popularity of lifecycle funds, which automatically shift an individual’s assets from riskier equities to safer bonds and money market funds as the person ages. India’s pension policymakers, clearly influenced by this trend, made a recommendation that uses this approach. How does it compare with other lifecycle funds? It’s quite conservative. The recent economic turmoil in global markets may be one reason why. (The report is dated February 17, 2009).

The recommendation is to have equity/bond/cash holdings move from 65 percent, 10 percent, 25 percent respectively for younger workers to 10 percent, 80 percent, 10 percent for retirees. (Equity and bond holdings are in Indian markets.) Once a person reaches age 35, the initial asset allocation begins to shift, reaching its final low-risk point when that person turns 60. The basic annual adjustment is to decrease equities by 2.2 percent each year, increase bonds by 2.8 percent, and increase cash by .6 percent.

How does this compare with privately available lifecycle funds here in the United States? To see the difference, let’s compare India’s recommendation to one of Vanguard’s lifecycle funds for younger workers. For readers who may not be familiar, Vanguard is one of the largest and most popular organizations for managing workers’ 401(k)s and Individual Retirement Accounts. One immediate difference is the date of retirement. The PFRDA picks a retirement date, age 62, whereas Vanguard offers retirement funds in 5-year increments (2010, 2015, 2020, and on) and asks a worker when she plans to retire. Based on that answer, the person works backwards and selects a fund closest to that date.

As a point of comparison, let’s take a 25-year-old worker and assume she will retire at age 65. The graph below shows the asset allocation shifts for the Vanguard target retirement 2050 fund and the PFRDA default fund. The Indian proposal is in blue; Vanguard in red. Solid lines stocks; Dashed lines bonds; Dotted lines cash. (You’ll see that Vanguard’s fund is barely in any cash until the very end of the cycle.) After age 70, only the Vanguard fund will change further – it will drop to 30 percent stocks by age 75. As always, fund managers may change these allocations at some point in the future.

It might seem a bit confusing at first, but here’s one easy and quick way to see how much more conservative the Indian proposal is. The point at which stocks and bonds cross is marked with a large dot. The Vanguard fund crosses more than 25 years after the Indian fund and at a higher overall stock-bond mix, about 50 percent versus 40 percent.

retirement-plans2

In it’s appendix, the PFRDA report considers more and less risky options. Interestingly, by its own numbers, the choice of initial equity/bond/cash allocations would not fulfill a rule based on maximizing the minimum amount of money an individual might earn through investment. A mix that starts at 45 % stocks, 30 % bonds, and 25 % cash is.

Default Fund: Total amount, Ages 25-62 (in millions of rupees)

Starting Investment Allocations

Least

Average

Largest

High: Equity = 80%; Bonds = 5%; Cash = 15%

7.43

19.57

96.4

Medium: Equity = 60%; Bonds = 15%; Cash = 25%

7.88

18.55

63.21

Low: Equities = 45%; Bonds = 30%; Cash = 25%

8.84

17.52

46.62

(The paper has the details on assumptions about wages and a monthly contribution amount.)

What the India example illustrates above all, is the differences that default rule choice architecture across the globe may look like, even for a single policy issue (retirement). Ultimately, a critique of from one choice architect to another is far less significant than the critiques – or satisfaction – that come from the humans operating within it.

One Response to “You really want to read about pension funds, don’t you?”

  1. Anonymous Says:

    I noticed that
    “The basic annual adjustment is to decrease equities by 2.2 percent each year, increase bonds by 2.8 percent, and increase cash by .6 percent.”

    should be “decrease cash by .6 percent.”

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