Research: Pension funds stabilise EU financial markets in good times and bad

Over the last two decades, pension funds have become dominant and fast-growing actors in global financial markets, driven by the significant shift from public pay-as-you-go plans to privately funded schemes. 

Their assets under management reached about $60trn (€56trn) by the end of 2021, representing 60% of global asset owners, according to WTW. Though more than half of pension funds’ assets worldwide are held in the US, their size has grown significantly in Europe. During the last two decades, pension scheme assets as a proportion of GDP has almost doubled from 14% to 27% in European Union countries, despite the 2008 global financial crisis and the 2011 European debt crisis.  

Since the financial crisis, emerging market countries, including European ones, experienced about $150bn in non-resident portfolio outflows, resulting in the destabilisation of financial markets. At this point, domestic and long-term providers of financial capital may offset the liquidated positions of foreigners by purchasing these assets at fire sale prices. Given their major importance and distinctive characteristics, pension funds have gained considerable attention for addressing the stability of financial markets in European countries. 

Pension fund advantage

The advantage of pension funds over other institutional investors derives from the fact that their liabilities are long term – they fund their investments from contributions of pensioners. Since they also have predictable cash outflows, they are unlikely to face unanticipated short-term liquidity needs. These characteristics allow funds to behave like investors with deep pockets. They can buy assets when prices have dropped and can benefit from the price increases. Moreover, the patient capital of pension funds encourages countercyclical investment strategies, especially in times of crisis. 

They finance their investments with contributions and are not leveraged. Funds are major providers of liquidity and collateral to the financial system, even in times of market stress. Anecdotal evidence by the Organisation for Economic Co-operation and Development (OECD) suggests that pension funds in several countries, including Portugal, Brazil, Poland and Colombia, followed a countercyclical approach during the financial crisis by increasing their exposure to equity investments (see chart). As a consequence of this buy-low and sell-high strategy, pension funds can bring asset prices closer to their fundamental values and thereby stabilise markets.

From a policy perspective, the positive impact of pension funds on financial stability is supportive of recent initiatives, such as automatic enrolment, that aim  to increase the size of private pensions. In the last decade, auto-enrolment has been introduced at the national level in three EU countries – UK (2012), Poland (2019)  and Lithuania (2019). Based on our findings, other EU countries may also consider implementing this policy, further supporting the stability of financial markets. 

Seda Peksevim is founder and managing director at Pensión Research & Consulting. This is a summary of her report, ‘Do pension funds provide financial stability? Evidence from European Union countries’, published in the Journal of Financial Services Research in 2023.