Pension funds’ foreign assets hit all-time high

Foreign assets held by Icelandic pension funds’ joint pension divisions now account for a record high of nearly a third of the funds’ total assets.

Foreign assets held by Icelandic pension funds’ joint pension divisions now account for a record high of nearly a third of the funds’ total assets. Total assets currently amount to just over one-and-a-half times GDP, after growing by a solid ISK 100bn per month in 2019 to date.

According to newly published figures from the Central Bank (CBI), Icelandic pension funds’ total assets amounted to ISK 4,549bn as of end-March. Of that total, joint pension divisions accounted for ISK 4,085bn and third-pillar divisions 460bn. The funds’ assets had grown by ISK 306bn since the turn of the year. The bulk of the increase (ISK 270bn) was in assets held by joint pension funds, the backbone of the domestic pension system.

Asset portfolios blossom with the coming of spring

According to Financial Supervisory Authority’s itemisation of pension funds’ asset position in Q1/2019, assets grew by nearly as much during the quarter as they did in all of 2018. The bulk of the increase is due to the pension funds’ foreign investments and to favourable developments in foreign markets. It should be noted, though, that Q4/2018 was a difficult one for the funds, with a steep drop in foreign stock prices, and the uptick in Q1 was largely a reversal of that decline.

Joint pension divisions’ foreign assets totalled ISK 1,292bn at the end of Q1, after increasing by ISK 190bn since the turn of the year. Foreign assets therefore accounted for 32% of total assets, also a record high. Only 18 months ago, for instance, the same ratio was 25%. Large-scale foreign asset purchases by the pension funds, the weakening of the ISK in the past year, and rising foreign markets have all pushed foreign asset ratios higher.

The pros and cons of accumulating FX assets

The pension funds’ need to rebalance their portfolios to include more foreign-denominated assets has long been a point of discussion, as the funds have been very active in the domestic capital markets. As a result, they are justified in diversifying risk so as to limit their exposure to Iceland’s small economy. The figures above show that their rebalancing efforts have been successful in the recent term. According to the CBI’s Financial Stability report, the pension funds’ foreign currency purchases totalled ISK 110bn in 2018 and nearly ISK 120bn in 2017. It can be argued that these purchases kept the appreciation of the ISK in check in 2017 and contributed to its depreciation in 2018. Be that as it may, our view is that the current exchange rate is much more conducive to internal and external economic stability than the considerably higher one we saw about two years ago.

But stepping up foreign assets brings problems as well. As the ratio of FX assets to total assets rises, so does the pension funds’ exchange rate risk. If it should happen that a group of prospective retirees draw pensions at a time when the domestic economy is flourishing while other economies are less robust, and if their pension funds’ foreign assets have lost value in ISK terms because of a strong currency coupled with weak foreign returns, the pensioners concerned could suffer a loss of income. Furthermore, there is no scope within the Icelandic financial system to hedge against this risk, aside from the partial protection afforded by the pension funds’ large size relative to the domestic capital market. This point has been made verbally and in writing by economist Gylfi Magnússon, among others.

Icelandic system the best in the world?

The Icelandic pension system is one of the sturdiest in the world, with assets equalling approximately 150% of estimated year-2019 GDP. It provides Icelanders’ main avenue for long-term savings, and in the recent past those savings have been channelled into foreign investments to a large degree. This can be expected to continue as long as the system grows and inflows plus returns suffice to cover pension benefits. In our opinion, however, there is no need to put an equal sign between the pension funds’ foreign investments and the current account surplus in the coming term. Inflows from inward foreign investment could easily bridge the gap, provided that those inflows are not used to maintain an abnormally high real exchange rate at the expense of external trade for a protracted period of time. In other words, FX flows stemming from the pension funds shouldn’t significantly distort the relative living standards of different generations, at the expense of either those on the brink of retirement or those in the early part of their working career.


Jón Bjarki Bentsson

Chief economist