Cost-benefit ratio of a pension fund: risk and return

Our quantitative comparisons of pension fund key performance indicators are based on the web database www.pensionpeers.ch from c-alm. Since 2016, more than 50 indicators have been extracted annually from pension fund annual reports with considerable effort and attention to detail. This dataset can be used for many purposes.

For example, to discuss the risk-return characteristics of a pension fund.

The theory is as follows: the more risk-tolerant a pension fund is, the more risk it can take in its investments. And the more risk it takes, the higher the returns it will generate on average. Naturally, everyone wants to be insured with a pension fund that generates the highest possible returns.

At the beginning of this cycle lies risk capacity. Those who want to be insured with a high-return pension fund must choose one with strong risk capacity. The legislator defines the concept of risk capacity in Art. 50 para. 4 BVV 2. Instead of defining a single metric, two factors are specified: firstly, the financial situation of a pension fund – measured by its coverage ratio – is relevant for its risk capacity. Secondly, the insured structure of a pension fund must be considered: the more active members and the fewer retirees a pension fund has, the more risk-tolerant it is and the more investment risk it can take.

Moving from theory to practice: if the theory holds true, one would expect that pension funds with higher risk capacity assume greater investment risks and therefore achieve higher returns over longer periods.

In this week’s chart we compared the average investment returns achieved by pension funds over the last five years with their financial reserves measured by the coverage ratio.

Indeed, the expected relationship – indicated by the upward trend line in the chart – appears to exist. The higher the coverage ratio as a measure of financial risk capacity, the higher the investment returns achieved between 2020 and 2024.

However, caution is required: the comparison may also be subject to a chicken-and-egg effect. A high coverage ratio may partly be the result of above-average investment returns achieved in recent years.

Nevertheless, when looking for a pension fund with strong future returns, it is advisable to focus on funds with high risk capacity. These typically have a healthy structure with many active members and relatively few retirees and possess financial reserves reflected in a high coverage ratio.