Pension funds may be defined as institutional investors, which collect, pool and invest funds contributed by sponsors and beneficiaries to provide for future pension entitlements of beneficiaries (Davis 2000). Therefore, pension funds provide an opportunity for individuals to accumulate savings throughout their working life to finance their consumption needs during retirement.
The financing will be received either in a lump sum or by provision of an annuity. Further, pension funds will provide funds to end users such as corporations, other households or governments for investments or consumption. Therefore, we can assume in a border aspect that pension funds operate as financial intermediaries within capital markets.
Pension funds and capital market
Pension funds operate and are perceived as substitutes and complementary institutions to other financial institutions, specifically to commercial and investment banks. Therefore, as competitors for household savings and corporate financing, pension funds create competition and may aide towards improving the loans and primary securities market (Meng and Pfau, 2010).
The growth of pension funds will encourage financial innovation, improvements in financial regulations and corporate governance, which will aide in the overall improvement in financial market efficiency and transparency through increased penetration by pension funds. This will widespread the number of interest parties and thereby demanding more information symmetry, stimulating long-term economic growth.
Contribution to economic growth
Capital has the role as the storage device for saving some of the current income for future consumption. The accumulation of these savings represents the wealth of a nation. Therefore, the higher capital productivity could be achieved through investing savings more productively and generating higher capital income.
This is more applicable for a country like Sri Lanka which has relatively low national savings to the GDP ratio of 24.7%, compared to the other regional countries such as India, China, Taiwan and Singapore, which record more than 30% national savings to the GDP ratio. Therefore, these countries possess relatively high domestic investments than Sri Lanka to fuel the economic growth.
Sri Lanka’s pension funds as a key source of long-term financial savings, holding approximately 20% of the GDP have to play a key role in enhancing the capital productivity by investing in high yielding instruments, with a calculated risk, enabling to create new capital base for the reinvestment needs of the country, in order to achieve a sustainable economic growth.
Key drivers of capital market
Long-term investors can support sustainable growth and financial stability since the structure of their balance sheets provides the capacity to smooth their resources over the medium and long term. They are not prone to herd mentality and are able to retain assets in their portfolios in times of crisis and in this way play a counter cyclical role.
Professionally managed long-term institutional investors can make an important contribution to growth in various ways, most important by financing long-term projects, such as infrastructure and promoting venture capital, etc. Further, they reduce reliance on the banking system, acting as shock absorbers at times of financial distress.
Long-term investments can also provide higher returns for long-term savings and thus, alleviating some of the funding gap that is widening due to low interest rates and an increased demographic burden.
The presence of large institutional investors is crucial for the development of the capital market of the country. In many markets, institutional investors such as pension funds, play a critical role in the stock market. Unlike the retail investors, large institutions invest with a long-term focus and are not affected by the short-term price fluctuations.
Since their investment capacity is relatively high, institutional investors can correct the stock market inefficiencies such as speculative actions, thereby stabilizing the market in the long run. In addition, the presence of large local institutional investors in the equity market is critically important to build investor confidence amongst the retail and foreign investors.
Hence, large institutional investors, pension and provident funds by investing in equity and debt instruments create long-term stability and investor confidence in a capital market. It is also imperative that institutional investors such as pension funds are professionally managed and have proper governance structures by adaptingglobally accepted standards of best practice and Code of Conduct for the governing body (CFA Institute). More specifically, the governing body should:
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