Pension funds face headwinds in H1

After several years of strong growth, Icelandic pension funds’ assets shrank by 5.4% in H1/2022, mainly because of falling prices in domestic and foreign securities markets. The funds’ real return on assets has been well above their actuarial threshold for the past decade, however, and when the markets liven up, so do their returns.

According to newly published figures from the Central Bank (CBI), Icelandic pension funds’ total assets amounted to ISK 6,386bn as of end-June. The decline relative to the turn of the year totalled ISK 361bn, or 5.4%, and stemmed mainly from falling share prices. The funds’ holdings in equity securities and unit shares contracted by ISK 102bn, and their foreign assets, mainly in the form of equities and shares in UCITS funds, shrank by ISK 343bn. On the plus side, the domestic loans and marketable bonds appreciated by ISK 75bn, and other assets grew by ISK 9bn.

The decline in the pension funds’ equity securities holdings was due mainly to the plunge in domestic and foreign share prices in H1/2022, after a steady rise of several years’ duration. For example, domestic share prices fell nearly 15% during the half, and the MSCI World share price index fell by 21% over the same period.

Presumably, then, pension fund executives will be heartened by the turnaround in July, which saw domestic share prices rise by an average of 7% and the MSCI World index by nearly 8%.

Slight decline in foreign asset ratio

The erosion of the funds’ foreign asset values has also lowered the ratio of foreign assets to total assets, which peaked at nearly 36% at the end of 2021 after share prices surged and the funds stepped up their foreign asset purchases. The same ratio had fallen to just under 33% by mid-2022.

The pension funds’ unhedged foreign exchange position is capped at 50% of total assets, although there are plans to raise the cap in stages over the next several years. There is little doubt that a higher ceiling will facilitate foreign asset management, as there have been occasions when individual pension funds have been forced to sell FX assets because their foreign asset ratio has exceeded or temporarily approached the threshold specified in their internal investment strategies. There are clear signs of this in the CBI’s data on pension funds’ foreign exchange transactions. According to CBI figures, the funds’ net FX purchases totalled ISK 56bn in 2020 and ISK 53bn in 2021. But in both cases, they sold currency at an accelerated pace in the final months of the year, presumably because they were shedding foreign assets.

In the first five months of 2022, their net FX purchases came to ISK 40bn, as compared with ISK 25bn in 5m/2021. As the chart shows, the pension funds shifted into high gear in May, buying currency for a net ISK 17bn.

The surge in their acquisition of foreign assets aligns well with changes in trade-related FX flows. As we see it, a turnaround is occurring in goods and services trade, as the vast increase in tourist visits, favourable developments in key exported goods prices, and weaker growth in domestic consumption and investment should combine to flip the recent current account deficit to a surplus in H2/2022. We think it wise that the pension funds should allocate a portion of this surplus to long-term savings outside Iceland, thereby mitigating the appreciation of the ISK that would otherwise have occurred and diversifying geographical risk in their investments.

Temporary setback after years of strong returns

It is possible that the pension funds’ real return on assets will prove to have been slender in H1, as their assets shrank in ISK terms even though inflows from payment of premiums were well in excess of pension benefits outlays. Our rough estimate suggests that their real return was negative by just over 10% in H1/2022,

but current and prospective pensioners need not despair. On average, the pension funds have delivered excellent real returns over the past decade in spite of fluctuations from year to year. For instance, their real return on assets for the period from 2012-2021 was 6.6%, nearly twice the actuarial benchmark of 3.5%, which they are required to use for settlement and restatement of total assets and liabilities. Although it is too soon to say with certainty whether the market rebound from June will be a lasting one, it is worth remembering that all storms are temporary, even those in the financial markets.


Jón Bjarki Bentsson

Chief economist