High equity exposure in the default fund “Såfan”

Jul. 07, 2015

Magnus Dahlquist is Professor of Finance and Head of the Department of Finance at the Stockholm School of Economics. He has studied the effects of the new pension system introduced in 2000 and recently attended the Pension Research Centre (PeRCent) Annual Conference in Copenhagen to give a keynote speak on the topic “Experiences from the Swedish Premium Pension System”.

– Going from a defined benefit to a defined contribution-system means that a greater responsibility is placed upon individuals. But overall, the Swedish system is stable both politically and financially and that is a great framework, from which you can fine-tune the details, says Magnus Dahlquist.

The design of default funds is something that Magnus Dahlquist, together with Ofer Setty and Roine Vestman, have studied in particular. The Swedish default fund Såfan, managed by AP7, is a well-diversified, low cost fund with a high stock market exposure. The fund design was changed significantly in May 2010 transforming the fund into a so called life cycle fund with a share of stock market exposure decreasing as the fund investor is getting older.

– I am positive to this set up but I believe it could be improved. We find that investors that stayed within the default fund typically have a lower income, less savings and a lower level of education compared to those who actively chose other funds. This means that the default fund holders are more dependent upon the premium pension system than other people for their retirement, says Magnus Dahlquist.

To further improve the situation for default fund holders Magnus Dahlquist proposes to condition the stock market exposure on a person’s savings outside the pension system and a cohort taking into account each generation’s historical exposure to financial ups and downs. He is also questioning the rather high stock market exposure of 150 percent for fund holders between the ages 20 – 55 years old. Although it makes sense for a 25 year old, it might be a good idea to decrease the exposure for investors closer to the age of 50.

An important, but less well-known feature of the premium pension system is that participants by default take a high equity exposure with them into the retirement phase. Magnus Dahlquist means that the high equity exposure can give rise to unwanted fluctuations in participants’ pensions. An alternative design would be to let the default pension be less risky and let those participants that want high equity exposure actively choose it.