Chapter 23 efficiency analysis in the spanish pension funds industry; a frontier approach

Precisely, the main objective of this research work is to evaluate the risk–return management beyond trading activities, taking into account three levels of analysis: a pension plan, mea

23.4 Defi nition of Variables and Descriptive Statistics

After t he European Commission established a single market for

pen-sions, pension plans have ex perienced a n important development in Europe Th is way, as a strategy to maintain the citizens’ standard of living, the private pensions industry takes a complementary role in respect to the exis-tent public pension schemes that, in recent years, have grown considerably

In parallel to their increasing importance, new questions arise: Do t he managers have the capacity to produce an effi cient assets management? Or, in

a less demanding way, are pension plans maintaining the purchasing power

of the funds invested? Precisely, the main objective of this research work is to evaluate the risk–return management beyond trading activities, taking into account three levels of analysis: (a) pension plan, meaning a co ntract that will give the investors the right to obtain a pension when the participant goes into retirement; ( b) pension f unds, say t he aggregated i nvestment i nstru-ment including several pension plans; and (c) management fi rms, meaning organizations that take care of the pension fund asset’s management.

Th e empirical application uses modern nonparametric frontier ods (additive frontier models) to determine the effi ciency of each one of the u nits u nder a nalysis Th ese methods a re especially applicable when the target to achieve is, at the same time, the expansion of the profi tability while contracting the level of risk

meth-As a starting point, we analyze the risk–return management of pension plans, checking to what extent the participation of the future pension-ers have any infl uence in the pension plan’s performance Aft er this, we examine the risk–return management in each management fi rm, taking into account the legal status of the parent company (savings bank, private bank, mutual insurance company, or insurance company) Eff ort will be put to determine to what extent the presence of diff erent objectives can exert any eff ect on the pension plan’s performance

Keywords: Pension f und, ma nagement co mpanies, effi ciency,

additive DEA estimation methods

JEL Classifi cation: G23

23.1 INTRODUCTION

Th e ac hievement o f a hig h le vel o f s ocial p rotection is a f undamental objective laid down in Ar ticle 2 o f the Treaty establishing the European Community Historically, the European social model has b een character-ized by its levels of prosperity, social cohesion, and quality of life However, the aging of the population, linked to other demographic problems, could imperil the ability to sustain the pensions system

Faced w ith t his situation, t he European Union supports a nd nates t he ac tions t aken by d iff erent member states I n t his context, t he reforms could aff ect the three basic pillars of the system: (1) the basic pub-lic regime, (2) the professional regimes, and (3) individual pension plans

coordi-In fac t, i n 2000, w ith t he objective of g uaranteeing for older persons a combination of regimes that would grant them economic independence, the European Commission itself recognized that many member countries

need to improve the second and third pillars In order to achieve a able system of adequate pensions, there is a need to improve supplemen-tary pension systems To reach this objective, the pensions forum was set

sustain-up and a proposal was drawn sustain-up for a directive of the European Parliament and of the Council (SEC (2005) 1293 of 12/10/2005) on improving the por-tability of supplementary pension rights among member countries

In this way, as a system supplementary to the public regime, pension plans acquire a g rowing i mportance, a s t he a mount received by t he i ndividual aft er retirement will enable him to maintain his quality of life For this rea-son, the effi cient management of pension plans could be the determinant in maintaining the participants’ purchasing power in the future Th is has raised great interest among professionals and academics, whose researches are cen-tered fundamentally on an evaluation of the effi ciency attained by managers (Christopherson et al., 1999; Collins and Fabozzi, 2000; Trzcinka and Coggin, 2000; Th omas and Tonks, 2001; Blake et al., 2002; Blake and Timmermann, 2005) through the traditional models proposed by Sharpe (1966), Treynor and Mazuy (1966), and Jensen (1968) and/or extensions of this last

In spite of the broad acceptance of these methods of evaluating effi ciency

in the management of portfolios, these indicators have been the subject of controversy regarding their limitations and disadvantages In this context, authors such as Cumby and Glen (1990) argue that Jensen’s alpha presents two limitations, which could generate biased estimators Th e fi rst of them con-sists in supposing that the manager bears a constant level of risk throughout the period under study, which, according to Grinblatt and Titman (1989b) and Collins and Fabozzi (2000), could generate biased estimators if the man-ager has the capacity of synchronization with the market Th e second criti-cism alludes to the adequacy of the reference index used On the one hand, the choice of the reference index aff ects the scale of the method proposed by Jensen (1968), as is pointed out by Lehman and Modest (1987) and Coggin

et al (1993) On the other hand, the omission of portfolios of reference could cause twists in the measurement of the results, as is demonstrated by Sharpe (1992) and Pastor and Stambaugh (2002)

As occ urs w ith J ensen’s a lpha ( Jensen, 1 968), t he T reynor’s i ndex (Treynor and Mazuy, 1966) suff ers from inconsistencies in its estimates, arising f rom i ts l ink w ith t he c apital a sset p ricing m ethod ( CAPM) With r espect t o Sha rpe’s r atio (1966), F erruz a nd S arto-Marzal (2004) and Israelsen (2005) i ndicate t hat t his generates consistent e valuations, although ma intaining t he co ndition t hat t he per formance o f t he f und analyzed must always be greater than that of the risk-free asset (a condition

by no means easy to meet, especially in periods of a falling cycle)

To the above criticisms, Murthi et al (1997) add that the traditional surements do not take into account the endogenous nature of the transaction costs, evidenced in Grossman and Stiglitz (1980) and Elton et al (1993) For this reason, to solve the limitations of the traditional indices, they propose

mea-a new memea-asurement, wh ich t hey obtmea-ain by mmea-a ximizing t he per formmea-ance for some levels of risk (the standard deviation) and given transaction costs, using the data envelopment analysis (DEA) technique In applying this mea-surement to a sample of 731 U.S investment funds, Murthi et al (1997) show that the measurement proposed is consistent with the traditional indices, off ers greater fl exibility, and allows sources of ineffi ciency to be detected

Th e objective of this work is precisely to present a DEA evaluation of the Spanish pension plans and, more specifi cally, to make an external evalu-ation i n which t he effi ciency of t he Spanish pension f unds is a nalyzed: (1) from the viewpoint of the rational investor who, under the suppositions

of fi nancial t heory, se eks to ma ximize t he profi t wh ile m inimizing t he cost, that is to say, obtaining maximum performance from the accumu-lated assets; and (2) from the perspective of the management entity, taking into account its objective of maximization of profi t and market share

In this sense, an important part of the income received by the ment entity comes from the commissions received for carrying out activi-ties of administration and management of pension funds In Spain, this commission has a maximum legal limit set at 2% of the assets; therefore, the management entity can increase its income in two ways: (1) by car-rying out effi cient management, from the viewpoint of fi nancial theory, which will enable it to add value to the fund and, therefore, receive more commission; and (2) by increasing its market share, recruiting potential clients who will make new contributions, and encouraging the making of contributions by already existing clients

manage-Th is could give place to the existence of funds that accumulate large volumes of assets, and this could have repercussions, as set out by Indro

et al (1999) and Chen et al (1992), on a reduction in the fund performance and, t herefore, of t he return for t he investor Th us, t his situation could originate, from the perspective of the agency theory, a co nfl ict of inter-est between t he ma nagement entity, which seeks to ma ximize its profi t

by applying its percentage commission to more and more assets, and the participant, who wishes to increase the yield

It is also well known that the fact that the management entity belongs to the same fi nancial group as the depository entity could also generate agency problems Th us, when the management entities propose as depository entity companies in the same group, in spite of the fact that they collect higher

commissions, they cause a reduction of the pension fund assets and, fore, of t he y ield to t he pa rticipant It can a lso occur t hat, in t hose pen-sion funds where the managing and depository entities belong to the same

there-fi nancial group, with the intention of benefi ting the group through the missions charged for the trading transactions in securities, there can be a turnover of securities greater than in those belonging to diff erent fi nancial groups, which would prejudice the investor who would see the value of his consolidated rights reduced and, consequently, the performance Th er efore, this action could create a confl ict of interest between the agent and the prin-cipal, which will be analyzed both from the perspective of fi nancial theory and from the perspective of agency theory

com-Th is research is relevant for (1) the management entities, as it will enable them to identify the factors that cause ineffi ciency in the fund, correct such ineffi ciencies, a nd i mitate t he best practices, benefi ting the industry as a whole; (2) the individual investor and/or promoter of the pension fund who, through the monitoring committee, must select the management entity that administers its assets, which is an important decision in the process of tak-ing decisions; (3) the controlling bodies and the legislators, as it will allow for an examination of practices in the industry and identify possible agency problems, as well as the quality and degree of information received by the participant and, depending on that, they will be able to modify or issue new rules that improve the competitiveness and degree of transparency of infor-mation in the market; and (4) the academic world, in general, as this study extends the empirical evidence in a market still unexplored, with a method-ology little used in the evaluation of effi ciency in pension funds

Th e rest of t he work is organized i n t he following way: S ection 23.2 presents a review of the literature relating to the evaluation of pension funds through the use of frontier models Section 23.3 describes the non-parametric frontier methodology, which will enable estimates of the level

of effi ciency to be made Section 23.4 defi nes the variables and presents the statistics descriptive of the data Section 23.5 discusses the results and also answers the research questions raised Finally, Section 23.6 concludes by summarizing the more outstanding aspects of the evaluations made

23.2 LITERATURE REVIEW

In t his work, we evaluate t he pension plans using nonparametric f tier evaluation methods For this reason, we base our literature review on existing works that use similar methods of estimation to evaluate pension plans and mutual funds In Table 23.1, we show a summary of works pub-lished, which evaluate the performance of mutual funds through the use

TABLE 23.1 Earlier Works on the Frontier Evaluation of Effi ciency

(2006) Portugal 12 EG1994–2003 DEA Cross-effi ciency DEA

Super-eeffi ciency DEA

No participants, total income

Excess return, stochastic dominance indicator

Output:

Gross average performance

Model AHP Inputs:No participants, total assets, total cost, own capital

Output:

Revalorization of assets at 1 and 3 years, net profi t

Performance 1, 3 and 5 years

MF Murthi et al (1997) United States

and administrative costs, turnover ratio, standard deviation

Output:

Annual return

of DEA models Th e fi rst works published on this industry are by Murthi

et al (1997) and McMullen and Strong (1998) Murthi et al (1997) evaluate through DEA a sample of 731 U.S investment funds In their conclusions, this research shows that the measurement proposed is consistent with the traditional indices, o ff ers g reater fl exibility, a nd enab les t he so urces o f ineffi ciency to be de tected For t heir part, McMullen and Strong (1998) use DEA as a tool for an investor, in the process of the choice of mutual funds, in accordance with a desirable combination of their attributes with the minimum possible costs

It immediately becomes evident that there is a limitation in the defi tion of variables by Murthi et al (1997), because the operative and other expenses—defi ned as inputs—are already deducted from the net perfor-mance of t he f und (just, t he output va riable), so t hat t here is a d ouble accounting For t his reason, Ba sso a nd Funari (2001) propose a m odi-

ni-fi cation of the model proposed by Murthi et al (1997), introducing, as inputs, alternative measurements of risk and expenses charged directly

to the participant (subscription costs and redemption costs) and, as puts, a stochastic dominance indicator, as well as the excess return Th e results o btained, o n a s ample o f 4 7 I talian i nvestment f unds, sh owed that this defi nition of variables gives more information than the tradi-tional indices, improves the classifi cation of the funds on introducing the expenses, and allows ineffi ciencies in the investment fund management

out-to be detected

Th e analyses by Murthi et al (1997) and Basso and Funari (2001) are done u nder t he tech nological su pposition o f co nstant r eturns t o sc ale However, as Choi and Murthi (2001) establish, investment fund managers could be aff ected by the existence of economies (or diseconomies) of scale, which could aff ect the fund performance To detect and control the eff ects

of scale in the evaluation of performance, Choi and Murthi (2001) amend the measurement proposed by Murthi et al (1997) by introducing a new variable capable of identifying the scale value, which could aff ect the per-formance of the fund Th e results obtained by applying the new measure-ment to a sample of 731 U.S investment funds indicate that, on controlling the eff ects of the economies of scale, a great many of the investment funds obtain similar effi ciency scores

Singularly, t he e arlier w orks a pply D EA m odels o n pos itive o utput variables However, in the presence of output variables with a negative sign, the DEA models are not without their problems To overcome this disadvantage, Hsu a nd Lin (2007) use the DEA technique, considering

the capitalization factor as an output variable, on a sample of Taiwanese investment f unds U sing t he s ame st rategy, Ba sso a nd F unari ( 2001) resolve the problem of negative output and examine a sample of invest-ment f unds ( ethical a nd t raditional) i n t he E uropean ma rket Th ei r conclusion is that, if we disregard the ethical character of the fund, tra-ditional investment funds come out as more effi cient than ethical invest-ment funds.

Taking the time factor into consideration, other authors such as Morey and Morey (1999) analyze the application of the DEA technique on mul-tiple time horizons, while Mcmullen and Strong (1998) introduce in their model p erformances me asured on v arious t ime hor izons a s a n out put variable

Th ese earlier works are referred to so a s to bring out the importance that the analysis of portfolio management has acquired in the scientifi c ambit a nd, e specially, t he e valuation of effi ciency by means of indices, which can overcome the limitations of the traditional measurements pro-posed by Sharpe (1966), Treynor a nd Mazuy (1966), a nd Jensen (1968)

Th ese new indicators have been broadly used to examine the investment funds i ndustry, a lthough i t i s t rue t hat pens ion f unds a nd p lans ha ve received less attention In this sense, improvements in the standards regulating pension plans have enabled transparency in the information available to be increased, which has encouraged the appearance of litera-ture on the analysis of effi ciency of the pensions industry through DEA methodology

Th us, Jablonsky (2007) uses the DEA technique with variable returns

to scale to analyze a sample of 12 Czechoslovakian pension funds, paring the effi ciency obtained through DEA methods of estimation with that re ached u sing a n a lternative e stimation mo del, c oncluding t hat there a re s ignifi cant diff erences b etween t hem However, t his a ffi rma-tion must be interpreted with caution since, as Dyson et al (2001) point out, Jablonky (2007) uses as input, variables measured in volume, and as output, a m ixture of variables measured in relative terms, which could generate inconsistencies in the results obtained when applying the DEA technique

com-Barros and García (2006) also use the DEA technique to evaluate the effi ciency of the 12 pension fund management entities existing in the Portuguese market, concluding that, in general, they show high manage-ment capacities However, to reach this result, they combine operational variables with fi nancial variables, which use diff erent units of measurement,

which can cause inconsistencies in the measurement of effi ciency Also, we

fi nd fl ux variables (contributions and benefi ts) and stock variables (assets and noncurrent fi xed assets) which, according to Resti (1997), are not very advisable for lack of homogeneity

Similar d isadvantages a re f ound i n Ba rrientos a nd B oussofiane (2005) This work applies an analysis in two stages to study the Chilean market of pension fund management entities In the f irst stage, they obtain ef ficiency i ndicators t hrough t he DEA model, considering a s input va riables t he s ales cost s, perso nnel cost s, a nd ad ministration costs As output variables, they use total revenues and number of con-tributors, using different units of measurement, which again runs the risk o f p roducing in consistent estimates S ubsequently, in a s econd stage, they apply a r egression analysis, taking as dependent variables the ma rket concentration, s ales spending, revenues, a nd t he r atio of contributors to a ffiliates, w ithout taking into account t he possibility that t here may be m ulticollinear a nd endogenous problems be tween the variables and the subject of study

Th e empirical evidence mentioned so far shows clearly the broad tance of the DEA technique to evaluate the effi ciency of institutions in the group investment industry In general, these methods off er diff erent advantages over the traditional models of effi ciency since: (1) they do not require a f unctional form of the performance-risk binomial or a r efer-ence index, (2) they encourage the incorporation of other factors, as well

accep-as performance and risk, which infl uence fund effi ciency, (3) they allow for the identifi cation of each ineffi cient fund and an effi cient combina-tion of funds, which could be made equivalent to a particular reference index and characterize the style of the portfolio, and (4) they encourage the identifi cation of best practices in the industry, systematically com-paring the elements generating results in one organization with those of other entities, thus enabling the agency relationships which, according

to Lakonishok et al (1992), exist in the industry, to be observed

In this sense, our research proposal diff ers in various aspects from the earlier works In the fi rst place, a large part of the literature existing on the evaluation of portfolios with DEA methodology is fundamentally centered

on the investment fund industry, while in this work we propose an analysis of the pension fund industry Th is could generate important diff erences in the results obtained, as the pension fund management entities and the invest-ment fund management companies work in diff erent legal environments

Second, t here a re d iff erences w ith r egard to t he g eographical ma ket Th e e arlier r esearch wa s c entered i n t he Portuguese, C hilean, a nd Czechoslovakian ma rkets, cha racterized b y ha ving d iff erent s tates o f growth and being governed by diff erent regulations On t he other hand, our work is centered on studying t he Spanish market, characterized by its recent creation (the fi rst pension plan began to be ma rketed in 1988)

r-To our knowledge, there is still no work evaluating frontier effi ciency as applied to Spanish pension plans

Th ird, t he earlier works had a r educed number of management ties Barros and García (2006) and Jablonsky (2007) used a sample of 12 management entities and 12 pension funds, respectively, and Barrientos and Boussofi ane (2005) use a ma ximum of 16 entities In contrast, our sample contains data from 660 funds and 1517 pension plans Th is gives us greater facility in incorporating variables on applying the DEA methodol-ogy, without having any problems of dimensionality

enti-Fourth, the earlier works use the traditional DEA models proposed by Charnes et al (1978), Banker et al (1984), Sexton et al (1986), Doyle and Green (1994), a nd A ndersen a nd Petersen (1993), wh ich require a ll t he variables to be defi ned with nonnegative values However, when intending

to examine the effi ciency of a group investment institution during the ing cycle of the fi nancial markets, it is probable that there will be negative performances For this reason, in our case we use an additive DEA model with variable returns to scale, which enables us to rescale negative vari-ables without the normal problems of translation invariance to which the literature alludes (Cooper et al., 2000)

fall-Finally, there are a lso diff erences w ith regard to t he inputs and puts u sed, a s c an be se en i n Table 23 1 I n t his wa y, J ablonsky (2007) introduces stock variables as inputs and fl ux variables as output On the other ha nd, Ba rrientos a nd B oussofi ane ( 2005) u se i ncome st atement accounts as input and add as output the number of participants Barros and García (2006) use as input the contributions and funds received, the number of employees, and the fi xed asset, and as output the number of funds managed, capital, and benefi ts Th us, a large part of the works men-tioned introduces stock variables as input (output) and fl ux variables as output (input), which can cause twists in the measurement of effi ciency Considering this can be a serious problem, our work only considers fl ux variables, drawn from the income statement, risk, performance, and asset variation

out-23.3 ADDITIVE MODELS IN DEA

As stated previously, standard DEA models require operating with negative variables However, depending on the cycle of the stock markets, negative returns are probable Although there has been proposals to deal with this problem (Hsu and Lin 2007; Basso and Funari 2001), their solu-tion causes problems because the property of “translation invariance” (meaning, although changes in the variables are introduced, the effi ciency coeffi cient r emains i nvariant t o t hese m odifi cations S ee C ooper e t a l 2000) is a property standard DEA models do not accomplish In our spe-cifi c case study, as in the time period we are going to analyze this problem

non-is particularly relevant, we decided to defi ne additive models that plish the property of translation invariance

accom-Additive models quantify the maximal sum of absolute improvements (input r eduction/output in crease m easured in “ slacks”) b y s olving, f or each unit under analysis, the following mathematical problem:

K

k k m i m im k

K k k

x x x x R is the vector of the observed inputs

corresponding to the unit under evaluation (unit i)

+

=[ ,,1 ,2, …, , ]∈ M

i i i i M

y y y y R is the vector of the observed outputs

corresponding to the unit under evaluation (unit i)

+

=[ ,,1 ,2, …, , ]∈ N

k k k k N

x x x x R is the vector of the observed inputs

corresponding to unit k, forming part of the sample containing K units

+

=[ ,,1 ,2, …, , ]∈ M

k k k k M

y y y y R is the vector of the observed outputs

corresponding to unit k, forming part of the sample containing K units

=[ ,1 2, …, K]

z z z z is the activity vector used to construct the

lin-ear segments of the frontier

Th e slack variables S i,n and S i,m, indicate the excess (shortage) of inputs (outputs) f or t he u nit u nder a ssessment t o be i n t he effi cient frontier

∑N n 1S i n, ∑m M1S i m, 0, the unit under evaluation is effi cient Say,

no other peer has been found that yields the same or bigger output tor with the same or smaller consumption of inputs As additive models are not invariant with respect to units of measurement (see Charnes et al 1985), previous to t he application of model (23.1), a ll t he variables have been normalized

vec-Th e underlying technology in program (23.1) exhibits variable returns

to sc ale I f co nsidered, o ther m ore su itable tech nological a ssumptions can also be introduced Th us, if we accept constant returns to scale as an acceptable technological choice, this can be defi ned dropping from (23.1) the restriction concerning the activity vector:

Other tech nological a ssumptions c an be made ma nipulating E quation 23.2 to defi ne nonincreasing returns to scale ( ∑K k= 1z k ≤1) or nondecreas-ing returns to scale ( ∑K k= 1z k ≥1)

23.4 DEFINITION OF VARIABLES AND DESCRIPTIVE

STATISTICS OF THE DATA

To analyze the effi ciency of Spanish pension funds, we have a s ample of

a total of 1517 pension plans of diff erent forms and between 658 and 661 pension funds For each pension plan, we have quarterly data relating to liquidity va lues, a nnual per formance, number of pa rticipants, acc umu-lated assets, form of t he plan, st yle of management, f und to which it is attached, and the fi nancial group to which it belongs for the period from 31/3/2004 t o 31 /12/2007.* Th e G eneral Di rectorate o f I nsurance a nd Pension Funds (DGSFP) has supplied information on the type of manage-ment entity and the type of depository entity in the plan Also, for each pension fund we obtain from the DGSFP the assets of the fund and how they are invested, as shown in the balance sheets, the management and

* Data obtained f rom t he A ssociation of G roup I nvestment a nd Pension Fu nd I nstitutions (INVERCO).

deposit commissions from the income statement, the form of the fund, and its date of foundation.

For those temporary series of pension plans which lack some detail ring to the accumulated assets, liquid value, participants, or annual perfor-mance, these have been completed using, as proxy, the value of the observation immediately previous in time On the other hand, to increase the method-ological precision we have eliminated from the sample those pension plans for which data for more than one consecutive quarter was lacking In this way, we have a complete panel in the sense that it only includes those pen-sion plans for which we have all the information for the date considered.From the above data, we have obtained the variables summarized in Table 23.2 Th e earlier international literature, Harper (2004) and Freeman and Brown (2001), establishes that the style of management adopted by the fund/plan could infl uence the eff orts and dedication of the manager to fol-lowing the evolution of the markets and the assets being traded in them

refer-Th us, the management entities which administer portfolios in which the investment objectives are centered principally on equities show greater management diffi culties than those portfolios composed entirely of fi xed income securities, as the equities market is more complex and the trading involves securities of greater risk than in the fi xed income market

For this reason, in the same way as Malhotra et al (2007), we incorporate

as a variable the style of management of the fund, adopting criteria lar to those established by Association of Group Investment and Pension

simi-TABLE 23.2 Descriptive Statistics: Categorical Variables

No of funds 148 248 262 658 140 260 261 661 Type of plan

O ccupational 14 138 73 225 13 136 76 225

I ndividual 134 110 189 433 127 124 185 436 Depository entities

B ank 72 135 131 338 64 130 139 333

Sa vings bank 76 113 131 320 76 130 122 328 Management entities

I nsurer 76 109 148 333 71 132 126 329 Pur e 72 139 114 325 69 128 135 332 Group

B anking 116 180 165 461 107 169 171 447

Ot hers 32 68 97 197 33 91 90 214

Fund Institutions (INVERCO) to cla ssify t he i ndividual pension plans

Th us, we group those pension funds for which the ba lance sheets show that their portfolios do not include equities in the category of fi xed income investment (FI), those funds which show in their portfolios between 0.1% and 25% of equities in the category of the mixed income investment (MI) and those with portfolios comprising more than 25% of equities in the category of variable-yield fund (VY) Th is enables us to compare the effi -ciency of the funds using as a benchmark the one which best assigns its resources, investing in similar classes of assets

We will now describe the variables, which will be used in analyzing effi ciency in the management of pension plans and the factors which can explain t he d iff erences f ound i n e ffi ciency l evels Table 23 3 sh ows a n ordered summary of these variables

We shall refer, fi rst, to the variables representing inputs Here, we fi nd

in fi rst place t he commissions borne Th ese commissions w ill depend

on the style of management adopted by the fund, as the management of equities generates higher administration costs than the management of a

TABLE 23.3 Glossary of Variables

Input variables for the effi ciency analysis

MGFEE (x1 ) Annual management fee as an absolute value expressed in euros

CUSTFEE (x2 ) Annual custodial fee as an absolute value expressed in euros

RETARDASSET (x3 ) Assets of each pension fund in euros in previous year

RISK (x4 ) Standard deviation annualized in quarterly performance of

the fund expressed in monetary units

Output variables for the effi ciency analysis

RETURN (y1 ) Annual return of each pension plan over assets (in euros)

FLOW (y2 ) Assets accumulated by the manager deducting performance

Other variables for the analysis of the factors having impact on effi ciency

OC Dummy variable = 1, if fund of occupational type, 0 otherwise IND Dummy variable = 1, if fund of individual type, 0 otherwise BANK Dummy variable = 1, if custodial company belongs to bank,

0 otherwise SAVBANK Dummy variable = 1, if custodial company belongs to savings

bank or credit cooperative, 0 otherwise INSUR Dummy variable = 1, if management company is an insurance

company, 0 otherwise EXCL Dummy variable = 1, if management company only manages

the asset pension funds, 0 otherwise

portfolio made up of fi xed income assets, since in Spain the negotiation

of variable-yield funds carries higher commissions than the expenses ated by trading bonds or other fi xed income investments, among others.According to Martí et al (2007), this increase in the costs of adminis-tration, management, and custody of the variable-yield fund with respect

gener-to t he fi xed i ncome i nvestment co uld be pa ssed o n t o t he pa rticipant through an increase in the management and deposit commission, estab-lished according to the Royal Legislative Decree 1/2002, of 29 November,

at a ma ximum of 2% and 0.5% over the assets of the fund, respectively

Th is commission represents on the one side the price that the participants pay to the professionals who administer their wealth and on the other the remuneration received by the management entity/depository for adminis-tering, managing, and custody of the fund assets (variables that we defi ne

as MGFEE (x1) and CUSTFEE (x2)) Th us, these commissions could infl ence the performance obtained by the fund, as is shown by earlier studies carried out by Lesseig et a l (2002), Brown et a l (1992), Ippolito (1989), and Grinblatt and Titman (1989a) For this reason, we will take them into account as variables to introduce into our model Th eir value is obtained through the product between the percentage of the management or deposit commission and the assets managed or in custody, respectively

u-Th e a mounts o f t hese co mmissions i n abso lute va lues w ill be d irectly related to the size of the fund/s administered For this reason, we believe that another factor which could be relevant in the study of effi ciency in pension funds is the volume of assets accumulated by them In this sense, the partici-pants of a pension plan, through the fund, put their assets at the disposal of the management entity, so that it can generate greater wealth for them Th ese assets constitute the concept on which the percentage of remuneration of the management entity is applied For this reason, with the objective of maximiz-ing its profi t, the management entity will seek to increase the assets of the plan/fund by (1) recruiting or encouraging contributions made by the participants, and (2) increasing the wealth of the fund through effi cient management

Th us, according to t he earlier i nternational l iterature, Ha rper (2004) and Indro et al (1999), management entities that administer substantial volumes of assets could benefi t from the existence of economies of scale,

as they incur lower average costs for administrative services and access to information supplied, and their size allows them to negotiate reduced bro-kerage commissions However, Wagner and Edwards (1993) affi rm that this type of commission represents only a small part of the total transac-tion costs borne by the funds

Coherent with this comment, Indro et al (1999) indicate that an trolled increase in the assets of a fund could make its management diffi -cult and increase the costs associated with it by: (1) increasing the problem

uncon-of a symmetry o f i nformation a nd l iquidity f or t he ma rket-makers; (2) restricting the manager’s capacity to operate in the market, as the mar-ket movements are of interest to the rest of the participants; (3) increasing the organizational complexity and, consequently, the problems of coordi-nation; and (4) raising problems of limited investment opportunities.Also, according to the results achieved by Ippolito and Turner (1987), there

is a direct relation between the size of the fund and the rotation of ties held in its portfolio Th erefore, the large pension funds could bear more commissions related to the trading of securities than more modest pension funds In this way, in view of the importance that the amount accumulated

securi-by the fund can reach in its management, we will introduce as input in the

proposed model the variable RETARDASSET (x3) as an amount obtained through the aggregate of the position accounts composing the pension fund

at the start of the year, representing the size of the fund in euros

Following the modern theory of portfolios proposed by Markowitz (1952), the objective of a rational investor is to maximize the performance

of his portfolio while minimizing the risk Applying this theory to the sion fund market, we can say that, for a rational participant, the objective of investing his wealth in a pension plan is to profi t from his investment while minimizing the risk Th us, pension funds are set up with this objective and the services of professionals and management entities which know how to administer the portfolios properly From the above, it can be deduced that the objective of the fund is to maximize the performance of its portfolio while minimizing the risk; for this reason, we think it is relevant to intro-

pen-duce as a va lue to be minimized (say, as an input) the variable RISK (x4), which shows the risk borne by the portfolio measured through the annual-ized standard deviation of the absolute quarterly performance, and as out-

put the variable RETURN (y1), which indicates the annual performance generated by the fund, obtained through the sum of the performances of the plans attached to the fund, and expressed in monetary units

Th e generation of wealth through effi cient management will contribute

to the increase in the remuneration received by the management entity However, the management entity can also increase its income by encour-aging contributions from the participants, contributions from the promot-ers, and transfers of potential customers toward the plans administered,

as is set out in Golec (2003) and Davis et al (2007) For this reason, we

incorporate into the model a la st output, the variable FLOW (y2), which represents the assets initially invested by the participants, plus the trans-fers and contributions obtained by the management entity Th e transfers and co ntributions a re o btained f rom t he d iff erence be tween t he a ssets

accumulated by the fund at time t and the assets accumulated by the fund

at time t-1 plus the performance generated during the period, expressed in

euros: Monetary Variationt = ASSETt− (ASSETt−1 + RETURNt)

Up till now we have described the basic variables, which will be used in the estimation of effi ciency in accordance to the program (23.1) However, more va riables a re needed to g ive a r esponse to t he research questions raised in this work Th eir descriptions are given in the following text

Th e organizational structure of the fund can infl uence its management

In t his sense , S panish l egislation, t hrough R oyal Dec ree 30 4/2004, o f

20 February, which approved the Regulation of Pension Plans and Funds, establishes diff erent standards of functioning according to their nature; distinguishing between the individual system and the employment sys-tem, as they cover diff erent levels of social benefi ts according to the model established in the Project for the European Code of Social Security

In the employment system, the promoter of the plan is a company and the pa rticipants a re t he em ployees Rep resentatives o f t he m onitoring committee of the plan are selected from the employees, whose functions include the appointment of the members of the monitoring committee of the fund to which the aforesaid plan is attached Th e representatives of the fund monitoring committee participate in the decisions which aff ect the investment policy of the fund, being able to delegate some functions to the management entity, which will be in charge of the administration and management of the assets of the fund with the cooperation of a depository entity A summary of the characteristics of the employment pension plan

is set out in Figure 23.1

In pension plans in the individual system, the promoter is an entity of

a fi nancial nature and the participant is any individual Th is plan must be attached to a pens ion fund, classifi ed as personal, if it integrates mostly plans in the individual and associated systems Th e contributions made

by the participant to the pension plan will form part of the fund assets, the ad ministration o f wh ich w ill be t he r esponsibility o f t he ma nage-ment entity with the cooperation of the depository entity, both institu-tions acting in the interest of the funds they administer and under the supervision of t he f und monitoring committee Th e representatives on the aforesaid committee are appointed by the promoting entities of the

plans composing the fund, taking decisions which aff ect the investment policy of the fund Figure 23.2 summarizes the principal characteristics

of this type of plan

Th us, in the cases of both the individual pension plans and the ment pension plans, the assets of the fund belong to the participants and/

employ-or benefi ciaries of it However, there are impemploy-ortant diff erences with regard

to participation in the taking of decisions on the investment policy of the fund In this sense, the participant of an individual pension plan acts as a client of the fund while the participant of an employment pension plan is like an owner of it in being able to take decisions which aff ect the invest-ment policy of the fund through the monitoring committee

Participants employees

Beneficiary

individual

Promoter entity, corporation, company or business

Occupational pension plan

• Supervision

• Control

FIGURE 23.1 Functioning of the occupational pensions system (From Legislative Royal Decree 1/2002 of November 29 and Royal Decree 304/2004 of February 20 Self-devised.)

Th e active participation by the investor in an employment plan in the investment policy of the fund can have an infl uence on the effi ciency of the f und ma nagement, a s it c an negotiate lower commissions w ith t he managing a nd depos itory en tities, r eplace t hem, dec ide wha t a ssets t o invest in, etc For this reason, we introduce into our analysis the variables dummy OC and IND that take value one when the pension is attached to

an employment fund or personal fund, respectively, and zero otherwise.Current legislation establishes that, as depository entities, any lending entity a uthorized b y t he G eneral Di rectorate o f I nsurance a nd Pension Funds may operate as such Th is means t hat savings ba nks, ba nks, a nd lending coo peratives c an a ll be depos itory en tities o f a pens ion f und

FIGURE 23.2 Functioning of the individual pension system (From Legislative Royal Decree 1/2002 of November 29 and Royal Decree 304/2004 of February 20 Self-devised.)

Monitoring committee

• Supervision

• Control

Depository entity

Beneficiary

individual

Promoter financial entity

Individual pension plan

C o n t r i b u t i o n

Control