Even though the form of Estonian pension funds has been showing signs of recovery lately, a recent report by the OECD suggests the general situation remains poor.
Estonian pension funds have been criticized over their poor performance for years. Management fees remain high, while productivity is among the poorest in the world. While the situation has improved in recent years – fees have been cut and productivity improved slightly – the OECD's recent pension funds report suggests the state of things remains unfortunate. It shows the average real rate of return of Estonian II pillar pension funds as the worst among the so-called club of wealthy countries. With inflation factored in, our pension funds have been burning 2.2 percent of investors' money annually over the past decade. Among the countries analyzed (that included several outside the organization), only three sported real rate of return (inflation is deducted from nominal rate of return) deficits over the past decade: Estonia, Latvia, and Bulgaria.
Even though inflation reached 10 percent and more during the boom in all three countries (the analysis covers the period 2005-2015), Estonian funds performed the poorest also in terms of nominal rate of return, reaching just 1 percent a year. The average nominal rate of return over the past ten years is 3.0 percent for Latvia and 2.6 percent for Bulgaria.
The analysis period covered both the economic boom and the depth of the subsequent crisis that devastated our pensions funds. Average real rate of return was -32.4 percent in 2008 that saw a third of our pension assets wiped away inside a single year.
Average real rate of return put our funds in the middle of the pack in 2015, amounting to 2.1 percent, good enough for 14th place among 31 countries. It has to be said, however, that the position owes mostly to deflation that boosted real rate of return. Last year's nominal rate was good enough for 25th place.
Pension funds performed best in Iceland last year, sporting average real rate of return of 7.4 percent, followed by Austria on 6.4 percent. Finnish pension funds managed an average real rate of 5.3 in 2015. Deficits hit Poland (-6.1 percent), Turkey (-5.9), USA (-1.1), and Mexico (0.8). US and Polish pension funds sported nominal deficits.
In addition to their poor rate of return, Estonian pension funds are also the most conservative, not to say timid. The relative importance of savings has only grown in our portfolios. If ten years ago the weight of money and savings in portfolios was just 6 percent, it grew to 20.2 percent last year. Our fund managers are sitting in money as financial specialists put it. The relative importance of savings was greater last year than even during the financial crisis in 2008, 2009 and in 2011-2012 when the European debt crisis had called into question the very survival of the euro area.
Savings play a more important role in pension funds only in Slovenia (23.1 percent) and South Korea, where money and savings make up roughly half of pension fund assets.
Savings exceed 10 percent of portfolios in just seven OECD members.
The poor performance of our pension funds has merited the attention of a group of entrepreneurs and financial specialists now working on cooperative pension fund Tuleva. The new fund manager started out by criticizing existing pension funds, calling into question excessive management fees and promising to launch a much cheaper fund in the near future.
The people behind Tuleva are more modest when it comes to rate of return as the advertised strategy – investing only in the global stock market's index and bond funds – should yield (global) average rate of return.
The finance ministry has also taken steps toward diversifying options for investing in pension funds in recent years.