Assessing Alternative Institutional Designs for Investment Regulation in Defined Contribution Pension Funds
This article provides a stylized framework to assess alternative institutional designs for investment regulation, in the context of mandatory defined contribution pension fund systems with individual accounts and competition among managers. We illustrate short-term, long-term and competitive risk-return frontiers, visualizing the differences in perspectives and incentives. We identify a potential “inefficiency trap”, meaning that if the benchmark is inefficient there will be no obvious incentives to move portfolios towards the frontier. We also argue that ceteris paribus competitive incentives will move managers to take more risk, either gradually or abruptly, with no obvious limits to this. We then discuss different institutional arrangements that could help in moving asset allocations towards efficient positions and to mitigate risk-taking incentives: minimum required absolute returns; maximum allowable short-term absolute risk; maximum allowable long-term absolute risk; and minimum returns relative to exogenous or endogenous benchmarks. We conclude that a setting with partially exogenous benchmarks and minimum return bands may constitute one of the better policy alternatives, despite its own limitations.