Following the decrease in stock markets in May, June turned out to be a brilliant month for investors. Measured net in euros, the MSCI World Index, which gathers the biggest stock markets in the world, rose by 4.3% during the month, which meant a new record high level for the S&P500 Index, which includes the shares of 500 corporations in the United States. Bond prices also grew, since the expected rates of return decreased.
Bond prices have risen so high that if they are maintained until the end, less money will be recovered compared to the amount that was invested in the purchase. About half of the Eurozone government bonds are currently trading at a price level that ensures a small but certain loss if they are maintained until their redemption date.
The Estonian Government also issued short-term government bonds that went to the local market last month. The entire issue was over-allotted many times and the result was that local banks were willing to pay the government in order to lend them money. This is the consequence of the European Central Bank's monetary policy, whereby the situation was largely created by rules (coercion).
In June, the value of bonds with a negative rate of return in the world amounted to around EUR 11 trillion. This volume is likely to increase in the near future as it is expected that the world's biggest central banks will soon open the money taps again. They can do this by lowering interest rates as well as by purchasing bonds from the market, which will further reduce the expected rate of return. The principal in case of a bond market means that the guaranteed losses will increase.
Financial markets are in a schizophrenic situation. Namely, rising share prices should show that the profits of enterprises will be higher in the future than they are now; however, bond prices are reflecting a deep concern for the performance of the world economy and geopolitical trends.
We made changes to our strategy
This year, the best rate of return has been provided by index funds, which always maintain the biggest proportion of shares permitted. Last year, index funds ended in negative territory. The results of the pension funds actively managed by LHV are below index funds this year, although we have made changes to our strategy which would provide the opportunity to exceed the wage growth objective entering into force in September.
The legislative amendments, concerning investment funds, which were adopted last year, alleviated the investment restrictions on pension funds and the growth of Estonian nominal wages was set as an objective for the rate of return (specifically, the amendment of social tax revenue). In order to achieve this objective, my team and I have also made major changes to the investment strategies of pension funds being actively managed by LHV.
More precisely, we have sold assets with a low expected rate of return during the last six months, and when making new investments, we avoid projects with a long-term rate of return of under 5%. In addition, we reduced the investments of pension funds into stock exchange listed shares, since we can see that the price level is very high compared to the expected profits of future periods.
Instead, we prefer to invest in projects with a higher expected rate of return. For example, private equity funds investing in small and medium-sized enterprises are still targeting an increase of 15–20% in the long-term value of the investments. If money is put into real estate, it is possible to achieve a rate of return of about 6% without using a bank loan and a rate of return of about 12–15% with the help of a bank loan.
Since the new objective set for pension funds is directly linked to the Estonian economy, then we will also significantly increase the proportion of investments made into Estonia.
Pension system as the battlefield of populists
Those who wish to break the second pillar in Estonia are a group of strange, unprincipled theatrical people, who will shout first and analyse later (if the latter is even done at all). At first they claimed that pension funds are like a bucket with holes in it, from which money is flowing out. Once it became evident that funds have more money than was originally put there, they came out with another claim that money in pension funds is burning with a bright flame because inflation is eating it away. When they were shown data, which showed that most funds have outperformed inflation, they began to demand that pension funds outpace wage growth as well.
With last year's legislative amendment, the critics were heard and comprehensive changes were made that help to increase the rate of return. Those opposing pension funds are still not satisfied with the situation. They claim that it is not possible to theoretically outpace wage growth and thus there is no point in having pension funds. They think that a law needs to be adopted which makes long-term investment complicated and almost impossible.
I have no doubt that by investing, it is possible to achieve a rate of return which will exceed wage growth in the long-term and I want to prove it with the help of relaxed investment restrictions. This has already been confirmed by the history of the world's financial markets: data about the wage growth and rates of return of financial markets is easy to find.
What really makes me wonder is that the demolishers of pension funds praise the free market economy but ignore the role of capital in the economy. In doing so, those same people who, in their own words, are fighting for the market economy, think it is appropriate to calculate the monetary value of people. To them, market economy and freedom of choice are simply expressions that are used to mislead the public.
Rain Lõhmus calls these destroyers – quite reasonably – communists. I consider them vain and unprincipled populists who are willing to sell everything for the smallest amount of attention.
If the pension system is reformed, then the main criteria, which every amendment has to correspond to, is whether and how much the pensions will increase in the future on the assumption that the tax burden on citizens will not increase.
Following the decrease in stock markets in May, June turned out to be a brilliant month for investors. Measured net in euros, the MSCI World Index, which gathers the biggest stock markets in the world, rose by 4.3% during the month, which meant a new record high level for the S&P500 Index, which includes the shares of 500 corporations in the United States. Bond prices also grew, since the expected rates of return decreased.
