ANALYSIS OF INVESTMENT ACTIVITIES OF NONSTATE PENSION FUNDS

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1 International Journal of Civil Engineering and Technology (IJCIET) Volume 9, Issue 11, November 2018, pp , Article ID: IJCIET_09_11_246 Available online at ISSN Print: and ISSN Online: IAEME Publication Scopus Indexed ANALYSIS OF INVESTMENT ACTIVITIES OF NONSTATE PENSION FUNDS Svetlana Anatolievna Khmelevskaya Lomonosov Moscow State University (MSU) , Moscow, Russian Federation Irina Urievna Orlova Joint-Stock Society "Stroykompleks" Non-State Pension Fund , Moscow, Russian Federation Dmitrii Nikolayevich Ermakov Russian University of transport (RUT - MIIT) , Moscow, Russian Federation ABSTRACT Investment activity is one of the most important activities of nonstate pension funds, which allows increasing the amount of pension savings of fund participants, protecting the actual value of savings against depreciation due to the inflation and, at the same time, providing the national economy with long-term investment resources. Modern nonstate pension funds in the developed world not only play the role of an institution aimed at providing pensions but are also considered in the context of investment policy. The article presents the analysis of investment activity of nonstate pension funds. The authors analyze problems of investment activities of nonstate pension funds, and international practices in their investment policy. The proposed recommendations with respect to investment activities provide an opportunity to improve the utilization efficiency of pension funds and provide more income to the participants of private pension provision. Key words: Nonstate Pension Funds, Investment Activity, Investment Policy. Cite this Article: Svetlana Anatolievna Khmelevskaya, Irina Urievna Orlova and Dmitrii Nikolayevich Ermakov, Analysis of Investment Activities of Nonstate Pension Funds, International Journal of Civil Engineering and Technology, 9(11), 2018, pp INTRODUCTION In the economically developed countries of the world, investment resources of nonstate pension funds (NPF) are effectively used in financing economic development programs. In terms of editor@iaeme.com

2 Svetlana Anatolievna Khmelevskaya, Irina Urievna Orlova and Dmitrii Nikolayevich Ermakov investment resources concentration, funds are comparable with banking institutions and have been recognized as the largest institutional investors. It is the development of the NPF system in the future that will contribute to the accumulation of population s monetary savings and their further transformation into investment resources for sustainable economic development of the state. Foreign practices in attracting financial resources of the NPF show that they are promising for effective use as investment resources. This is due to the fact that it is these funds that are both performing social-protective function and serve investors holding long-term financial resources [9]. Based on the aforesaid, the aim of the present article is to analyze the investment activities of NPF and the evaluation of their effectiveness. 2. PROBLEM ANALYSIS OF THE NPF INVESTMENT ACTIVITIES The investment potential of the NPF is based on investment resources, which are characterized by specific features of formation. The NPF depositors pay pension contributions in favor of the fund participants. The accumulated contributions are placed on the financial market into pension assets, and the aggregate of pension contributions and investment income (or loss), received from their placement in assets, constitutes pension savings of the NPF participants, which are recorded in individual pension accounts. Part of the pension savings is directed to the fulfillment of the current obligations of the NPF, including the pension payments. The rest of the pension savings is directed to the formation of pension assets. Total amount of pension savings, as well as the retained investment income of the NPF composes investment resources of the NPF. Thus, investment resources of the NPF are understood as a set of pension savings on individual pension accounts of fund participants formed through the pension contributions of depositors and investment income (loss) received from their placement in assets [1]. This definition of investment resources of the NPF, firstly, emphasizes the earmark nature of funds, namely, it indicates that these are "pension savings", that is, funds intended for the payment of pensions; secondly, through the definition of pension funds as a set of pension savings on individual pension accounts of the fund participants, it is clearly determined, who is the owner of such funds; and thirdly, the given definition distinguishes the formation sources of pension funds (pension contributions of depositors and investment income (loss) received from their placement in assets). The specific features of the NPF investment resources are their monetary form, use for financial investments, long-term investment horizon, certainty of investment terms, etc. Regulation of investment activity of the NPF is important, because, on the one hand, it should encourage funds to effectively invest in the national economy and direct investment resources in certain branches of production and services industries that need to be developed in specific regions for a specific period of time. On the other hand, state regulation aims at improving the reliability of pension provision in general, creating conditions for guaranteed return of invested funds, preventing situations of nonfulfillment of the NPF obligations to depositors. There are two main approaches when regulating investment activities of the NPF, namely, the establishment of strict investment restrictions, or the application of the so-called "prudent man rule", in which investment restrictions are minimal. Regulation of investment directions of pension assets is carried out in the form of a direct prohibition, quantitative restrictions, or requirements for obtaining permission to carry out an investment transaction editor@iaeme.com

3 Analysis of Investment Activities of Nonstate Pension Funds Restriction of choice of investment objects is regulated by establishing the following regulatory documents [2]. 1) A list of approved classes of financial assets that can be purchased by funds. Such "permitted" assets are those types of investments that have acceptable levels of insolvency and liquidity risks; 2) A list of prohibited assets (securities issued by persons related to the NPF, or other types of assets that are considered too risky or low liquid); 3) Maximum percentage levels of "total" investments in certain asset classes. Such restrictions exist for investments with a high degree of insolvency or liquidity risk. It is common practice to impose maximum restrictions on transactions in securities that are not listed in an organized market with low-quality corporate bonds and certain classes of foreign securities. In some countries, restrictions on low-risk investments (government securities or high-quality bonds) are minimal; 4) Maximum restrictions on the proportion of "aggregate" investments in a one investment object. This restriction is used for investments in securities of one issuer or in one real estate object in order to ensure adequate diversification of the portfolio. This requirement regulates the reinvestment of the NPF in the parent company or its subsidiaries on the terms of acquisition of shares or on the terms of lending; 5) Requirements with respect to compliance of the currencies of assets and liabilities, i.e. the minimum percentage of assets to be invested in the same currency(s), in which the liabilities will be paid. These requirements relate to currency risks and the possible depreciation of the currency in which the investment is made at the date of payment of liabilities; 6) Restrictions on the use of derivatives for trading or speculative purposes. In this regard the inspecting authorities establish regulatory norms on the creditworthiness of suppliers of over-the-counter derivative (OTC derivatives). It should be noted that investment restrictions have a number of adverse effects, in particular the effect of "herd behavior", when the portfolios of different NPF are very similar and their yields are almost the same. Also, regulatory rules have weak incentives to improve the efficiency of investment management. Moreover, in developing countries, the range of investment products is usually very limited, therefore the NPF control large sectors of markets in which they can invest, creating liquidity problems. Thus, taking into account the effect of "herd behavior", in those periods when the acquisition or sale of assets is carried out by the majority of funds at the same time, market prices can vary greatly (in an unfavorable direction), increasing the systemic risk in the capital market. Another problem related to investment constraints is that they do not allow achieving the desired diversification level of investment. While restrictions help to avoid an excessive concentration of risks, they cannot ensure adequate diversification. Therefore, the implementation of the principle of adequate diversification without upper limits may, in fact, be more effective in achieving the objectives of reasonable diversification. Ideally, investments should be made through organized exchanges into high-rated securities that are actively quoted. Any exceptions should be subject to a clear limitation. Thus, the state imposes restrictions on the investment of the fund in order to minimize the possibility of reducing the value of the fund's net assets. Diversification of pension assets in accordance with the current legislation helps to reduce the riskiness, and contributes to adequate liquidity of the investment portfolio. In order to be effective, investment constraints must be flexible and reviewed in accordance with the approaching to maturity of the NPF, and, accordingly, before capital markets are editor@iaeme.com

4 Svetlana Anatolievna Khmelevskaya, Irina Urievna Orlova and Dmitrii Nikolayevich Ermakov modernized and become more efficient. However, the long-term goal of the NPF investment regulation should be the transition towards "prudent man rule". Practice shows that the real return of the NPF that operate on the basis of "prudent man rule" is higher than that of funds operating under investment restrictions, mainly due to the higher proportion of shares in investment portfolios. Nevertheless, the difference in returns cannot be fully explained by investment restrictions since in many countries such restrictions are not inhibitive when choosing an investment. The "prudent man rule" does not provide for the establishment of strict restrictions on investments, the main attention is paid to the regulation of the investment managers behavior. The "prudent man rule" is an investment standard, which was introduced in the English- American pension system in order to evaluate the behavior of asset managers. The rules stipulate that asset managers must act prudently, professionally, competently, and responsibly. One should distinguish "prudent man rule" from the rules of prudential regulation, consisting of the following rules: relatively full disclosure of information by companies; fiduciary responsibility; licensing of management companies; mandatory establishment of depository institutions; rules for assessing assets at market value; rules preventing the potential occurrence of conflicts of interest; and prohibition to invest in certain types of assets. Investment restrictions can be justified at the initial stage of the implementation of nonstate pension provision. However, there is a need to ease investment restrictions in the course of time as the financial market develops, the liquidity of the securities market improves, the regulatory framework perfects, etc. Liberalization of investment restrictions may concern the following areas: increasing the proportion of investments in stocks, foreign assets and less liquid assets such as real estate and venture capital. The long-term goal should be aimed at adopting "prudent man rule" when minimum investment restrictions are imposed. 3. ANALYSIS OF INTERNATIONAL PRACTICES OF THE NPF INVESTMENT POLICY The growth in the number and scope of activities of institutional investors in developed countries since the 1960-ies of the last century to the present time is explained by some scientists and researchers by influence of structural changes and the growth of capital markets [3; 4]. As a result, many countries with economies in transition have chosen the development of an investment investor system as a strategic development benchmark. It should be noted that in many countries with economies in transition, assets at the disposal of institutional investors have increased significantly. According to Western researchers, this trend is due to the beginning of pension reform, primarily the introduction of the funded component [5]. According to the analytical and statistical data of the Organization for Economic Cooperation and Development (OECD), the total assets of institutional investors for the period of have increased by 56.5 trillion USD (260.37%). At the same time, total assets of pension funds in the OECD countries have increased by 14.5 trillion USD (198.63%) over the study period [6]. In turn, the assets of pension funds account for 28% of the total assets of institutional investors. Analyzing these data, one can state that the assets of institutional investors in the OECD countries were growing primarily due to the development of the NPF. In addition, the development of the NPF affects the development of stock markets. According to scientists, the editor@iaeme.com

5 Analysis of Investment Activities of Nonstate Pension Funds favorable effect of the NPF investment activity is the fact that it entails intensive economic growth by increasing the rate of savings and efficiency of securities markets [7]. The OECD countries, where nonstate pension provision is practically undeveloped (Finland, France) are characterized by high regulatory requirements for limiting the investment of the NPF assets [3; 11]. In countries such as Australia, Belgium, Ireland, Luxembourg, the Netherlands, and New Zealand, there are no restrictions on the assets investment limits of NPF, while in Iceland these requirements are essential [3; 11]. One can note that Russia also has regulatory requirements regarding restrictions and prohibition of investment of pension assets. According to the research, the largest proportion in the amount of investment of these funds in the OECD countries are bonds (Table 1) [8]. Table 1. Distribution of the NPF assets by investment tools in some OECD countries in 2016, % [8] Country Shares Bonds Cash and deposits Other USA Australia Belgium Finland Netherlands Denmark In the OECD countries there are differences in the development and implementation procedure of the NPF investment policies depending on the types of pension plans. Defined contributions scheme will differ from defined benefit scheme given differences in purposes. When using the NPF schemes with defined contributions, a single investment goal is defined that provides clear and measurable objectives, which are to maintain and increase the capital of participants both in nominal and real terms for a long time [8]. To achieve this, it is necessary to implement effective investment strategies and processes, strictly approach to risk management and planning of the appropriate budget, as well as to the investment cost management. The main complicating factor for the NPF assets investment providing defined benefit in the OECD countries is the need to correlate them with liabilities [8]. The problem is that from the perspective of the funds, their obligations are practically uncovered, especially in the case of secondary payments to persons dependent on deceased pensioners. This category of investment involves a high degree of diversification of investments by asset class, and the like. In some countries, the presence or absence of a significant amount of the NPF assets invested abroad may be due to the securities market behavior [8]. This issue is partially solved through legislation by limiting the proportion of assets of funds that can be invested abroad. The restriction applies to the proportion that can be invested in assets of a certain class, or category of investment, or the exchange on which the shares are traded. In most countries, there are no restrictions on foreign investment. In the OECD countries, restrictions on investment activities are applied in two forms: 1) Denmark, Germany, Poland, Switzerland, and Japan have restrictions on the amount of funds that can be invested in shares (usually 30-40% of all NPF assets); 2) France and Portugal have introduced restrictions in the form of a minimum proportion of investment in government securities. Although this minimum varies from 15 to 50%, it has almost the same effect on limiting the proportion of shares in the portfolios of pension funds editor@iaeme.com

6 Svetlana Anatolievna Khmelevskaya, Irina Urievna Orlova and Dmitrii Nikolayevich Ermakov In practice, the structure of the NPF investment portfolio depends generally on the managers behavior model, which has historically developed in a certain country. Thus, in continental Europe, the NPF managers adhere to conservative views, therefore the proportion of assets of these funds placed in shares is lower than the established limits in comparison with other countries. In Austria, France, Germany, Italy, Spain, and Switzerland this figure mainly varies around 10%. In English-speaking countries such as Australia, Ireland, the UK, and the USA pension funds keep in shares from 40 to 80% of their assets. Latin American countries, in terms of their indicators, are somewhere between these two groups. As one can see, conservatism in investment preferences cannot be explained by regulatory restrictions alone. 4. PROPOSALS FOR THE NPF INVESTMENT PORTFOLIO BUILDING A clear definition of the NPF objectives in the relevant general economic conditions is necessary to ensure their effective operation. We believe it relevant to divide the goals into three types, namely pessimistic, optimistic, and break-even objective. Ensuring the protection of pension assets against inflationary depreciation is a pessimistic goal, and it is relevant in times of economic instability, crisis, and political turmoil. If the pension asset management company aims at providing sufficient investment income to cover inflationary depreciation and reimburse current expenses (to pay for the services of the administrator, custodian, asset management company, and other operating costs) then one deals with a break-even goal. The optimistic goal is achieved when the investment income is sufficient not only to preserve pension assets against inflation and payment of current expenses of the fund, but also to provide a net profit of 3% per annum and more. Thus, the minimum program aims at protecting pension funds against depreciation and conducting cost optimization. The maximum program is to provide as much income to future pensioners as possible, but this is usually associated with a risky investment strategy to ensure maximum investment income. According to international practices, an effective approach when investing NPF is searching for the optimal investment portfolio in general, rather than searching for the most profitable securities. According to the risk/return-criterion, an effective portfolio is defined as that having either the highest expected return at a limited level of risk, or the lowest level of risks at an established return. In this context, four types of portfolios should be considered, divided by the risk criterion of investment policy and the age of participants. We propose to divide the participants by age into four groups, which correspond to the proposed division of portfolios into the following types: up to 25 years (the most aggressive portfolio), years (moderately aggressive portfolio), years (cautious portfolio), and over 55 years (restrained portfolio). This is logical, because young employees have a reserve of time necessary to form pension savings and can afford a higher level of investment risk, which cannot be said about the participants of the preretirement age. Each portfolio should include the types of assets available for investment, but in a different proportion. Provided that the legal restrictions on the pension assets structure remain unchanged, and no new financial instruments will emerge on the financial market, the composition of these portfolios may be as follows. The most aggressive portfolio could include shares (40%), corporate bonds (30%); government bonds (5%), municipal bonds (5%); deposits (15%), other assets (mainly shares and bonds of foreign issuers), real estate, and bank metals (5%) editor@iaeme.com

7 Analysis of Investment Activities of Nonstate Pension Funds The moderately aggressive portfolio could consist of shares (30%), corporate bonds (25%), government bonds (15%), municipal bonds (5%), deposits (20%), other assets, real estate, and bank metals (5%). Cautious portfolio includes shares (20%), corporate bonds (15%), government bonds (25%), municipal bonds (5%), deposits (25%); real estate and other assets (5%), and bank metals (5%). Restrained portfolio consists of shares (10%), corporate bonds (10%), government bonds (35%), municipal bonds (5%), deposits (30%), real estate and other assets (5%), and bank metals (5%). Types of assets are distributed in the portfolio according to their profitability and risk levels. Summarizing the above, we can calculate the approximate profitability of each of the proposed investment portfolios. Since pension payments from funded levels of the pension system start many years after the beginning of old-age accumulation, it is important to react in a timely manner to possible loss occurrence of these funds in consequence of a failed investment or large operating costs, so that it is not too late to protect the rights of participants. With this in mind, the need for different methods of evaluating the performance of administrators and pension fund managers is of great importance. 5. CONCLUSION Given the positive foreign practices, we can offer the following to preserve and increase the assets of the Russian NPF: To improve the diversification efficiency of the investment portfolio of the funds by investing in securities of foreign issuers, which are reliable and profitable in the international stock market. To optimize the approach towards the supervision over the NPF investment. In our opinion, successful practices for Russia should be the approach to the supervision of NPF investment based on risk assessment. Such approach is used in many OECD countries, and is focused on the prevention of investment risks and protection of pension assets. The approach to investment supervision of NPF will allow identifying unprofitable investments and implementing measures to prevent losses of funds. The proposed recommendations on investment activities provide an opportunity to improve the efficiency of pension funds and provide greater income to participants of nonstate pension provision. REFERENCES [1] Abramov, A., Radygin, A., Chernova, M. and Aksenteva, K. Effektivnost' upravleniya pensionnymi nakopleniyami: teoreticheskie podkhody i empiricheskii analiz [Efficiency of managing pension savings: Theoretical approaches and empirical analysis]. Economic Issues, 7, 2015, pp [2] Chashkov, S. A. Pravovye problemy gosudarstvennogo regulirovaniya v sfere investirovaniya nakopitel'noi pensii grazhdan RF [Legal problems of state regulation in the field of investment of pension savings of the Russian Federation citizens]. Scientific Notes of Pacific National University, 6(4), 2015, pp [3] Ageeva, E. V. Negosudarstvennye pensionnye fondy: kurs lektsii [Nonstate pension funds: A course of lectures]. Irkutsk: Publishing House of Baikal State University, editor@iaeme.com

8 Svetlana Anatolievna Khmelevskaya, Irina Urievna Orlova and Dmitrii Nikolayevich Ermakov [4] Smolnikova, E. V. Sushchnost' i spetsifika protsessov upravleniya negosudarstvennym pensionnym fondom [The nature and specificity of the management of nonstate pension fund]. Business in Law, 2, 2015, pp [5] Pallares-Miralles, M., Romero, C. and Whitehouse, E. International patterns of pension provision II. A worldwide overview of facts and figures. World Bank, Washington D.C., Discussion Paper, 1211, [6] OECD. OECD Core Principles of Private Pension Regulation [7] Borsch-Supan, A., Koke, F. and Winter, J. Pension reform, savings behavior and capital market performance. Journal of Pension Economics and Finance, 4, 2005, pp [8] OECD. Pension markets in focus [9] Dudin, M. N., Prokof'ev, M. N., Fedorova, I. J. and Frygin, A. V. The world experience of transformation of innovative approaches to assurance of financial stability of social economic systems. Life Science Journal, 11(9), 2014, pp [10] Dudin, M. N., Kucuri, G. N., Fedorova, I. Ju., Dzusova, S. S. and Namitulina, A. Z. The innovative business model canvas in the system of effective budgeting. Asian Social Science, 11(7), 2015, pp editor@iaeme.com