Pension Funds' Asset Allocation and Participant Age: A Test of the Life-Cycle Model

By Bikker, Jacob A.; Broeders, Dirk W. G. A. et al. | Journal of Risk and Insurance, September 2012 | Go to article overview
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Pension Funds' Asset Allocation and Participant Age: A Test of the Life-Cycle Model

Bikker, Jacob A., Broeders, Dirk W. G. A., Hollanders, David A., Ponds, Eduard H. M., Journal of Risk and Insurance


This article examines the impact of participants' age distribution on the asset allocation of Dutch pension funds, using a unique data set of pension fund investment plans for 2007. Theory predicts a negative effect of age on (strategic) equity exposures. We observe that a 1-year higher average age in active participants leads to a significant and robust reduction of the strategic equity exposure by around 0.5 percentage point. Larger pension funds show a stronger age-equity exposure effect. The average age of active participants influences investment behavior more strongly than the average age of all participants, which is plausible as retirees no longer possess any human capital.


The main aim of this article is to assess whether Dutch pension funds' strategic investment policies depend on the age of their participants. A pension fund's strategic investment policy reflects its objectives, presumed to be optimizing return, given the risk aversion of its participants, while the actual asset allocation may depart from the objective as a result of asset price shocks, since pension funds do not continuously rebalance their portfolios (Bikker, Broeders, and De Dreu, 2010). In this article, we focus particularly on the strategic allocation of assets to equities and bonds as representing, respectively, risky and safe assets. The argument for age-dependent equity allocation stems from optimal life-cycle saving and investing models (e.g., Bodie, Merton, and Samuelson, 1992; Campbell and Viceira, 2002; Cocco, Gomes, and Maaenhout, 2005; Ibbotson et al., 2007). An important outcome of these models is that the proportion of financial assets invested in equity should decrease over the life cycle, thereby increasing the proportion of the relatively safer bonds. The key argument is that young workers have more human capital than older workers. As long as the correlation between labor income and stock market returns is low, a young worker may better diversify away equity risk with their large holding of human capital.

Dutch pension funds effectively are collective savings arrangements, covering almost the entire population of employees. This article verifies whether pension funds take the characteristics of their participants on board in their decision-making on strategic investment allocation, and to what extent. We investigate whether--in line with the life-cycle saving and investing model--more mature pension funds pursue a more conservative investment policy, that is, whether they hold less equity in favor of bonds.

For pension funds' strategic asset allocation in 2007, we find that a rise in participants' average age reduces equity holdings significantly, as the theory predicts. A cross-sectional increase of active participants' average age by 1 year appears to lead to a significant and robust drop in strategic equity exposure by around 0.5 percentage point. As a pension fund's asset allocation is determined by many other factors, this awareness of the optimal age-equity relationship and its incorporation in their strategic equity allocation is remarkable. We also find that the equity-age relationship is stronger for active participants than for retired and deferred participants. (1) This is in line with the basic version of the life-cycle model where retirees should hold a constant fraction of their wealth in equities, as they no longer possess any human capital. We also observe that other factors, viz. pension fund size, funding ratio, and participants' average pension wealth, influence equity exposure positively and significantly, in line with expectations. Pension plan type and pension fund type, however, do not have significant impact.

The negative equity-age relationship has been found in other studies as well. For pension funds in Finland, Alestalo and Puttonen (2006) report that a 1-year average age increase reduced equity exposure in 2000 by as much as 1.

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Pension Funds' Asset Allocation and Participant Age: A Test of the Life-Cycle Model


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