Optimal Risk/Return Trade – Off of the 2nd Pillar Pension Plans in Latvia

Abstract

The 2nd pension pillar in Latvia started to operate in 2001 but systematic quantitative research of all pension plans still has not done. There are 21 pension plans in 2nd pillar and participants always arise a question – which pension plan better to choose.

The aim of this research is to make a quantitative analysis of all 2nd pension pillar pension plans and define the best ones for participants with high, medium and low risk tolerance.

The general statistical analysis of the 2nd pillar pension system has done to bring out the risk/return ratio of each pension plan, the holding period return, the assets over participant ratio and the growth speed of the system in the last five years. Markowitz method of optimization is used to determine the optimal risk/return situation in active, balanced and conservative investment plans and identify the best pension plans by its strategy. The risks and returns of each pension plan were evaluated and compared to the several benchmarks. To test the people’s knowledge about their pension plans, the survey was carried out and compared with the viewpoint of professionals.

It was found that there is a large disproportion between the optimal allocation of 2nd pension funds and the actual investment structure. Lack of knowledge of the general public about pension plans was identified. Practical recommendations for pension plan participants have worked out in each risk category, depending on person’s risk appetite.