Illustrative photo.
Photo: Zane Bitere/LETA
12:36, 25 December 2023
Author: Kārlis Purgailis, chairman of the board of “CBL Asset Management”, a subsidiary of “Citadele” bank
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The profitability of Latvian citizens’ pension savings directly depends on events in the world financial markets and the skills of local pension managers to choose a successful investment strategy. How successful has this year been for pension managers, which pension plans have performed with the highest returns and which events have had the biggest impact on our savings?
This year, the three main drivers of the global economy were inflation, rising interest rates and the breakthrough of technology companies.
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Although the year began with predictions of a sharp slowdown in the global economy and fears of an impending financial crisis, stabilization of inflation, the triumph of artificial intelligence and the earnings of large technology companies reinforced the optimism of investors around the world. It was also possible to overcome the threats caused by the energy crisis in Europe and the bankruptcy of banks in the USA and Switzerland.
The military conflict in Israel was the reason for the market correction at the beginning of the 4th quarter of this year. Despite the initial tension, both the Ukrainian and Israeli wars were priced from an investor perspective shortly after they began as a local conflict that would not have lasting effects on the global economy. On the condition that there is no further escalation of the conflict.
Best results for active plans
The mentioned factors have greatly contributed to the increase in the value of the largest stock indices – if in 2022 the financial market experienced a significant decline (the decline of the S&P500 was recorded at certain times as much as 25%), then in 2023 the direction was directed upwards – the S&P500 increased by more than 22%, the European The index of the 600 largest companies – by 14%, and the index of developing countries – by less than 5%.
The rise in the world financial markets is also reflected in the pension savings of Latvian residents – the yield of all level 2 active plans within the year ranged from 9 to 20%. These are plans where investments in shares of various companies can make up to 100% of the plan’s content, and they have been the most profitable this year.
Active plans are traditionally the segment where the highest returns can be observed, but they can also experience the steepest declines as a result of financial market fluctuations. Higher return potential and the ability to amortize risks over a longer period of time are the two main reasons why active plans are recommended for those with at least 10 more years until retirement.
Kārlis Purgailis.
Publicity photo.
What affects the profitability of conservative plans?
The struggle of central banks with inflation and the rise of interbank interest rates in the past year significantly affected the bond market (as rates rise, the value of bonds falls) and, as a result, also conservative pension plans. Conservative plans are primarily made up of government and corporate bonds, which offer a guaranteed rate of return that depends on the maturity of the bonds and the credit risk of the borrower.
When creating conservative plans, the pension manager makes a choice in favor of fixed income to ensure that the pensioner’s savings are protected from significant potential declines caused by financial market shocks, corrections and prolonged recessions. This is especially relevant for those residents who are approaching retirement age, that is, there are about 5 years left until retirement.
Taking into account the dynamics of the market in 2023, the yield of conservative plans has been around the 4 to 6% mark within the year, but the reduction of central bank interest rates expected in 2024 means that the potential of these plans could increase.
Invest at the right time
The positive trend in Latvia is that pension level 2 savings continue to increase – the amount of savings has reached a record high of 7 billion euros. This can be explained by the increase in the average salary in the country and correspondingly higher contributions, as well as by the significant profitability from the positive development of the financial markets. Of the total pension level 2 savings, almost 1 billion euros have been formed from the result of investments.
When it comes to voluntary investments in the 3rd level of pensions, we see that citizens tend to invest money when there is a relatively successful period in the financial market.
It would be correct to do the opposite, that is, to make contributions at times when the market is undergoing corrections, because then the relevant assets can be purchased at more attractive prices.
Unfortunately, experience shows that in such moments, residents are more willing to withdraw money and record losses. For this reason, for that group of people who do not follow what is happening in the financial market on a daily basis, the correct approach would be to make regular contributions during the year, because then the investment price will be equalized in the long term and the potential growth of savings will be higher.
What to expect next year?
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As for the future, market participants are increasingly convinced that we will not see a full-scale financial crisis in the near future, which does not rule out a moderate continuation of the economic slowdown in the 1st quarter of 2024.
Against the backdrop of Europe, the US economy looks stronger, so it will be interesting to see which of the central banks – the FED or the ECB – will be the first to decide on a reduction in interest rates. This step is expected not only by bond investors, but also by representatives of companies and citizens with active credit obligations. The rhetoric of monetary policymakers about the gradual lifting of restrictions for the next year allows us to look optimistically enough.
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2023-12-25 10:46:18
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