Although bank sales representatives may suggest otherwise, splitting your Pillar II and Pillar III assets between several pension funds with similar strategies does not help spread your risks. So what does help?
Tuleva has a firm principle: we never try to lure anyone into our fund by tugging at their sleeve in a shopping centre or pestering them over the phone. Instead, we make financial truths that seem complicated as simple as we can, so that everyone can make an informed choice and create the best conditions for their pension assets to grow. To do that, we talk in person as much as possible with our members and savers, to understand what raises questions and what the biggest obstacles are to saving wisely for the future.
We wrote the first version of this blog post back at the end of 2017, but we have kept updating it based on feedback from savers.
What does the feedback show?
- We have heard that some people didn’t even know Tuleva also has Pillar II funds. Many people know us as the Pillar III fund manager that quickly became the largest in Estonia (in Estonian). Yet Tuleva started with Pillar II funds, and that is where most of the assets we manage are saved. It’s the large size of our Pillar II funds that allows us to keep lowering our fees.
- Some people think that switching Pillar II funds costs money or takes a lot of time. That’s not true. The Ministry of Finance listened to Tuleva’s proposal and, from the start of 2017, banned fund managers from charging a high exit fee on top of their other fees when you leave a fund. Thanks to this, moving your units from one fund to another is free for everyone in Estonia and takes a few minutes with our guide.
- And then there are people who have left some or all of their Pillar II assets in an old bank fund because they are trying to spread their risks that way. Most of them have admitted that they got the idea of diversifying from bank sales staff. Here’s what I think about that: before Tuleva came along, bank tellers and sales representatives in shopping centres never recommended “spreading risks” between different pension funds. It seems that since Tuleva was born, this has become a common practice to persuade people to leave at least part of their assets ticking away in a high-fee fund.
Spreading risks is very important in investing. It’s just as important to understand which risks need to be managed, why, and how it can be done.
Business risk: can a fund manager go bankrupt?
Estonian law protects all of us very effectively against the business risks of a pension fund manager. Over the last 10 years, several fund managers have closed down, and many of their fund’s savers probably didn’t even notice (for example, ERGO and Danske). If Tuleva, for example, were ever to close its doors for some reason, the Financial Supervision Authority, together with our depositary bank (SEB), would simply hand investors’ assets over to the next fund manager to take care of, and nothing bad would happen.
Your assets are always kept separate from the fund manager’s money. By the way, savers’ monthly contributions go directly from Pensionikeskus to the depositary bank and from there to the world’s securities markets. And if the management of a Pillar II fund manager were ever to do something malicious, the state Guarantee Fund would compensate investors for the loss.
So in all Estonian pension funds, your assets are well protected against the fund manager’s business risks. You don’t need to split your assets between different funds yourself, because that doesn’t spread your risks any further.
By the way, this also holds in the worst-case scenario. Most of the assets of Estonian pension funds are held outside Estonia, and if war were to make it impossible for fund managers to operate in Estonia (in Estonian), that would not mean losing the fund’s assets. However, disruption to business in Estonia could, for a while, prevent pension fund units from being redeemed. In Estonia, the redemption of all pension fund units is organised by the state through Pensionikeskus.
Market risk: what protects against swings in stock prices?
In our view, investing your pension assets in the world stock market suits most savers. By keeping our savings in a low-fee, broadly diversified stock fund, we create the best conditions for the purchasing power of our assets to grow. The history of financial markets gives us reason to hope so: over the last 100 years, the long-term average return of the world stock market has comfortably beaten inflation. That is exactly why nearly 95% of Tuleva’s savers have chosen the Tuleva World Stocks Pension Fund.
At the same time, the money in our pension fund is exposed to market risk, because stock markets are cyclical: a rise is followed by a fall, and a fall by a rise. But this shouldn’t discourage us as long-term savers. After all, our goal is to set money aside consistently and build up as many assets as possible for the day we want to start using them, and the ups and downs along the way don’t concern us.
Splitting your assets between actively managed funds or index funds of different fund managers does little to manage market risk. If you want to reduce market risk (for example, if you plan to start using your pension assets in the next few years), you might consider moving part of your assets to a low-risk bond fund or to wait in a pension investment account (PIK). Low costs matter a great deal for low-risk funds too, because bond returns are limited and a high fee can eat up much of them. It’s also worth knowing that a bond fund carries investment risk too, meaning the value of your assets fluctuates, although less than in a stock fund.
For most savers who still have at least five years before they use their savings, a low-fee index fund that invests in stocks is still the best fit. There, a simple and elegant risk management tool works for you most effectively: dollar cost averaging, i.e. spreading your purchases over time (in Estonian). There is also no reason to choose a low-risk fund if you plan to use your pension assets as regular payouts (in Estonian).
Geopolitical risk: are my assets protected in case of war?
Unfortunately, fears related to geopolitical risk are very real right now. Are our pension assets protected, and how, if a state of war were to arise in Estonia? Would we still be able to access our pension assets?
At Tuleva, we don’t invest specifically in Estonia, and all our assets are outside Estonia. Our fund’s assets are invested in the index funds of BlackRock, the world’s largest fund manager, which in turn invest the money in the shares of nearly 2,500 of the world’s largest listed companies. A war in Estonia would not affect the value of our investments. The unit register of BlackRock’s index funds is kept by JPMorgan, one of the world’s largest banks. The units owned by Tuleva’s pension funds are held in a separate account in that register.
Keeping pension assets outside your home region helps spread risks. A typical index fund portfolio, like Tuleva’s, consists of holdings in the world’s largest listed companies. They would keep operating even in a very bad and unlikely scenario.
However, access to the assets of all pension funds currently depends on Estonian law. Unfortunately, no one can say exactly what the laws might become in the event of a coup. I wrote more about geopolitical risk in this article (in Estonian).
In summary: so how should you spread your risks?
If you want to achieve the best long-term return and don’t plan to withdraw all your Pillar II assets within the next five years, it makes sense to choose a low-fee index fund that invests in stocks. Direct both your savings so far and your future contributions there. Then be patient, and let the strategy of spreading your purchases over time (in Estonian) and the growth of the world economy do their work.
But when the time to use your pension assets is getting closer, think through the smartest way to do it. This blog post (in Estonian) will help you.
Switching pension funds is free and takes a couple of minutes. Do it now, because the sooner you stop paying high fees on your assets, the bigger the share of the profit earned on your assets that stays with you.
