This book focuses mainly on searching for measures to evaluate the performance of pension funds. Currently fund performance is mostly assessed via short term measures. This is remarkable, as the specific nature of pension funds suggests that this is not adequate and can generate adverse incentives. The goal of pension funds is to ensure and facilitate a constant smooth real consumption stream over the life cycle, which appears inconsistent with the focus on short-term nominal returns.
This book provides a thorough review of different ways to measure pension fund performance, which is a particularly important topic. The crisis made especially apparent the pressing need for assessing the performance of pension funds. Focusing on the returns at short horizons can inadvertently give rise to suboptimal risk taking behavior. The contribution of Olivia Mitchell and others is thus more than welcome in the current policy practice and will motivate pension funds to evaluate their performance in ways that are more consistent with their long-term objectives.
The first chapter motivates the relevance of this topic particularly well. The question is placed in its context and time and it is immediately clear to the reader why at this moment it is necessary to re-evaluate how to measure pension fund performance. The focus on the transition from DB to DC (and collective DC) and the impact of this on the assessment of performance is particularly interesting. Furthermore, the different chapters of the book are placed in perspective. In effect the reader is taken by the hand, and gets a preview of the chapters to come and how to link them. As a reader, I found this however necessary, since I am not sure whether the dots are connected easily without a roadmap.
The main purpose of the second chapter is to present the reader with descriptive statistics on the performance of pension funds in several countries. The analysis is thorough and comprehensive, and it was particularly interesting to see not only statistics on Western countries, but even including for instance Kazakhstan. This illustrates the wide scope of the countries examined.
A nice essay by Eduardo Walker and Augusto Iglesias described various measures to evaluate pension fund performance. However this chapter mainly discusses “old” measures which are used currently. The authors elaborate on the various risk adjusted measures such as the Sharpe ratio and whether they are suited for comparison between pension fund performance in different countries.
Chapter 4 expands on this by also taking into account the imposition of minimum return guarantees. In contrast to the previous two chapters, this section is highly mathematical in nature. In this respect the book is a bit volatile. On the one hand several chapters are qualitative, others present easy to comprehend descriptive statistics, while at the other extreme (especially chapter 4) there is some tough mathematics to work through. The volatile nature of this collection of essays is more a weakness than a strength, because I think academics and practitioners mostly have a strong preference for one or the other, but not both.
Chapter 5 is a relevant topic and differs from previous chapters in an excellent way. Instead of focusing on returns to measure pension fund performance this section elaborates on an alternative measure: the income replacement rate. This is defined as the amount of income a retiree receives compared to a worker income level. Various measures of worker income level are discussed. The income replacement rate seems to be an especially relevant measure, because in the end the goal of a pension fund is to deliver an adequate income after retirement to its participants. This should be kept in mind and it is great that the book elaborates on this. Furthermore this section focuses on the effect that labor income risk has on pension fund performance in various pension systems.
Building on previous chapters and mainly chapter 5, Fabio Bagliano, Carolina Fugazza, and Giovanna Nicodano propose another benchmark for evaluating pension fund performance. In contrast to measures that focus only on returns, they develop a measure which takes its members labor income risk and pension risk into account. If, for instance, there is a positive correlation between equity returns and labor income risk, this should be reflected in the portfolio allocation of the pension fund. For this reason they propose a welfare ratio, which compares the welfare obtained if the optimal pension policy is undertaken, compared to a suboptimal policy. However, it seems that even though this is an excellent framework for thinking about the pension fund policy from an ex ante perspective, it might not be an adequate way to examine ex post pension fund performance. This chapter could have benefited from elaborating more on how to use this welfare ratio framework for ex post pension fund evaluation.
Chapter 7 takes a broad perspective on the issue of pension fund performance evaluation. Not only the effects of human capital on optimal pension policies are discussed, but also the contributions and other sources of retirement income. In my opinion, it might be good to not only focus on the effect of (riskless or risky) labor income, but also other background risks. However, I would have liked a more elaborate discussion on what can “reasonably” be taken into account when designing a pension system. In theory all income sources and risk have an influence on optimal 3 choices. However, at some point we have to stop taking into account some heterogenous aspect of participants and assume it to be homogenous. Furthermore this chapter elaborates on some very important issues, such as the use of inflation indexed bonds and currency hedges.
The last chapter consists of views of four experts on pensions, Keith Ambachtsheer, Olivia Mitchell, Luis Viceira, and Zvi Bodie. This essay is very interesting and stimulating as it contains the opinions on key issues concerning the performance evaluation of pension funds from leading experts. It was especially easy to read and gave a lot of food for thought, for instance the “to-do list for practitioners” and “to-do list for researchers” in the first part by Keith Ambachtsheer.
In the opinion of this reviewer, this book will appeal to both practitioners and academics. It is a great book, which has a very thoughtful design and gives a good overview of the current issues with pension fund performance measurement. Given the recent crisis, the topic of this book is particularly important and pressing at this moment. And when things are going wrong, it is much more apparent that there is a need for change.
