The return of Estonian pension funds is on its way to number one in the Baltics

The average real return of Estonian pension funds was almost equal to that of Lithuania in 2020, and the ratio of pension assets to the GDP in Estonia is the best in the Baltics, according to the OECD’s annual report.

According to the OECD, between December 2019 and December 2020, the real returns of Lithuanian (4.9%) and Estonian (4.8%) pension funds were almost equal. The corresponding figure for Finland was 4.6% and for Latvia, 2.4%. A year earlier, Lithuania was the leader of the OECD table with 16.6%, followed by Latvia (7.7%) and Estonia (6.6%). In the case of Estonia, the final return of pension funds has been published, i.e. the management fee has been deducted from it.

Mexico (9.3%) had the highest real return on pension funds among OECD countries. Similar to the previous period, the Czech (–1.2%) and Polish (–4.8%) pension funds showed a negative return in 2019–2020.
As a ratio to the GDP, Estonia has the largest pension fund assets in the Baltics (19.5%), followed by Lithuania (9.5%) and Latvia (2.1%). The OECD average is 63.5%, with pension fund assets accounting for 210% of the GDP in the Netherlands and 194% in Iceland. The corresponding percentage for Finland is 56%. Therefore, compared to many developed countries, the pension assets of Estonia are still small and almost no one receives employer’s pension.
In total, the pension assets of OECD countries grew by almost 9% in 2020. In Estonia, assets increased by 11.5% year-on-year, ranking us second among the Baltic countries, coming after Lithuania (15.9%) and before Latvia (9.0%).

Restrictions on share investments and inflation have previously hampered the return of Estonian pension funds

Last year, Estonia reduced the gap with countries with better returns, and there are several reasons for this. ‘Estonia has historically had restrictions on investing second-pillar pension assets – for example, in the early years, pension funds could only invest up to 50% of their assets in shares. Over the years, this restriction has been relaxed and in 2019, second-pillar pension funds entered the market in Estonia which were allowed to invest all of their assets in shares. The strong rise in the stock market in recent years is certainly reflected more strongly in pension funds, where the percentage of shares is higher. However, the percentage of share investments in Estonian pension funds is still less than half,’ said Peeter Schamardin, Business Development Manager of SEB Varahaldus.

He also emphasised that traditionally, inflation in Estonia has been higher than, for example, the average in Western Europe. ‘The nominal returns of Estonian and Dutch pension funds may be equal, but if Estonian inflation is, for example, 2% higher per year than in the Netherlands, the real returns of Estonian funds are automatically two percentage points lower. As Estonia is a member of the euro area and the structure of our economy is becoming more and more similar that of developed countries, the inflation rate of Estonia and the so-called old euro area countries should converge in the longer term. This should help Estonian funds to win higher places in the future,’ said Schamardin.

Endriko Võrklaev, Fund Manager of SEB Varahaldus, added that the Estonian funded pension system is still quite young and our people have not been able to save for 40–50 years, as pensioners in many developed countries have done. ‘There have been periods in the past where the return of local pension funds was not sufficient and fund managers can undoubtedly learn from the past. On the positive side, however, at the beginning of the saving period, when the accumulated amounts are still small, the returns have a relatively smaller effect. The well-being of future pensioners is more determined by the performance of the funds in the second half of the saving period, when the accumulated pension assets are already significant. The relaxed regulation of Estonian pension funds, lower fee rates, and a growing body of experience create good prospects for the future to achieve better positions in the table,’ said Võrklaev.

The pension reform of Lithuania differed from the Estonian one in several respects

According to Võrklaev, Lithuania winning the first place in the OECD list in 2019 reflected their pension reform at the time, during which the risk level of pension assets was suddenly changed, moving a large part of bond investments to share investments. In Estonia, on the other hand, a large part of the money of pension savers is still in funds with a large bond component, which do not meet the return expectations and risk tolerance of many pension savers. ‘The fact that 2019 was exceptionally positive for stock markets took Lithuanian funds to the forefront last year. As the current year has also started positively for the stock markets, there is reason to expect positive news from Lithuanian funds in the future as well. The Lithuanian pension reform differed from the Estonian reform in several respects: instead of disbursing pension money, the focus was on improving the return of the funds and, in addition, numerous experts were involved in the implementation of the reform,’ Võrklaev noted.