Academic journal article The Lahore Journal of Economics

Asset Allocation for Government Pension Funds in Pakistan: A Case for International Diversification

Academic journal article The Lahore Journal of Economics

Asset Allocation for Government Pension Funds in Pakistan: A Case for International Diversification

Article excerpt

Abstract

Reforms have begun in Pakistan to sustain the funded pension scheme for government-operated pension schemes such as the Employees Old Age Benefit Institution (EOBI). Presently, the EOBI operates its own fund and invests most of its assets in government-backed securities which are basically interest-bearing debt instruments. Although the returns on the EOBI's fund have been high for a short period due to higher interest rates and minimum pension distributions, this trend is not likely to continue. Funded pension schemes depend heavily on portfolio performance because risk is transferred to contributors. Therefore, asset allocation becomes considerably important. The purpose of this study is to determine optimal asset allocation and the role of international diversification specifically for the EOBI's funds and generally for newly created funded pension schemes in Pakistan. The article analyzes the potential benefits accrued through international investments based on historical returns over almost five decades with varying degrees of risk aversion coefficients. Varying degrees of risk may allow policymakers to incorporate their strategies for future asset behavior and take timely action to counter the potential threat of aging, demographic shifts, and liabilities and to ensure decent benefits for pensioners.

Keywords: Asset allocation, international diversification, pension fund, Pakistan.

JEL Classification: G11, G23.

1. Introduction

Pension reforms have become an important part of public policy across the globe and Pakistan is no exception. The existing pay-as-you-go (PAYG) or defined benefit (DB) schemes in which the government guarantees an agreed level of retirement benefits to government servants are losing favor due to demographic trends, unfunded future liabilities, higher fiscal deficits, and lower benefits for pensioners. These factors have prompted governments to gradually replace PAYG schemes with either fully or partially funded pension schemes where risks are borne by contributors to the fund rather than by the government. Keeping in view the above factors, the federal and provincial governments of Pakistan are implementing reforms by introducing funded pension schemes such as the Punjab Pension Fund, which became operational in 2009. Other provinces will follow suit. Also, the federal government is considering a funded pension scheme for federal government servants in order to provide resources for the economic development of Pakistan under the newly approved National Finance Commission Formula 2009.

Currently, there exists a government-operated pension scheme known as the Employees Old Age Benefit Institution (EOBI) for private workers of small and medium firms/establishments. The federal government intends to carry out meaningful reforms to the EOBI to make it economically viable and sustainable through actuarial valuations, converting it into a state pension scheme for employees based on defined contributions and benefits. Since retirement benefits in fully funded pension schemes depend on portfolio performance, asset allocation becomes important. Therefore, attention should be paid to reforming the EOBI's existing investment strategies. The EOBI invests in domestic assets as international investments are prohibited, but funded pension schemes invest more in foreign securities than defined benefit schemes (Jorge, 2004). The purpose of this study is to determine optimal asset allocation and the role of international diversification specifically for the EOBI's fund and generally for newly created funded pension schemes in Pakistan. The paper will analyze the potential benefits accrued through international investments based on historical returns over almost five decades with varying degrees of risk aversion coefficients. The varying degrees of risk may allow policymakers to incorporate their strategies for future assets and make timely decisions.

Asset allocation is a portfolio choice among broad investment classes. …

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