Pension funds could do small business space some favours

This article appeared originally in Gulf News: link to original article

A good pension fund is one that offers an optimal balance between youth unemployment and an adequate payout in the future.

Other factors related to a pension fund, such as the contribution rate and retirement age, are supplementary to balancing out youth unemployment and future payouts, which in my view are at the core of how a country must establish and manage it pension fund.

There is no question that the world’s financial system has been meshed into a global one, where actions taken by certain countries can have direct or indirect ramifications for others.

As such, and in the same light, pensions funds are also becoming part of this globalised financial system.

The investment strategies they formulate, and the steps that they take to have them implemented, impact individuals across most countries, not least because of the sheer size of those funds and their geographic breadth.

The Government Pension Fund Global, or the Norwegian sovereign wealth fund, owns “1.4 per cent of all of the world’s listed companies”, which comes to 9,158 companies across 73 countries.

While this particular fund has no obligations to pay future pensions despite its name, others do not enjoy a similar luxury even when their names do not specifically spell it out.

In all cases, the effective management of those funds over the years can ensure the adequate payout referred to earlier. But what about youth unemployment?

The traditional way of measuring how good a pension fund is rests on how many working individuals must be contributing to a single individual’s retirement payout, measured within the country’s borders. Moving away from a micro to a macro view of pension funds, those funds, given their mega-scale investments and outreach, are exposed to the shifting economic and financial dynamics in the countries that they have invested in.

This subsequently brings me to my second point of what a good pension fund must always balance out — and that is youth unemployment.

As pension funds become more globalised, the pension notion of younger populations subsidising retiring ones also becomes a globalised one too. This means that current and future youth populations — mainly in the Middle East, Africa and a few Asian countries — will be subsidising retiring populations in their regions and beyond. The same youth however are faced with unemployment, putting further emphasis on the importance of job creation that is tailored to them.

In 2017, youth unemployment averaged 16.84 per cent worldwide, with 54 countries having a youth unemployment rate of more than 20 per cent, as per the (World Bank). Meanwhile, sovereign wealth funds (SWFs), including pension funds, have seen their assets under management increase to $7.45 trillion between March 2017 and March 2018, an increase of about 13 per cent, according to media reports.

Among the biggest gainers was Norway’s SWF or pension fund. Not all pension funds were as lucky though.

The Japan Government Pension Fund, the world’s largest, which actually has current and future pension obligations, lost more than $100 billion towards the end of 2018. Norway will face a similar problem whenever it decides to pitch in towards pension payouts from its current SWF. Add to that the perils of youth unemployment, and the future for pension funds seem far from certain.

Resolving the challenges with youth unemployment will be a key issue to grapple with in coming decades. More importantly, public sectors are beyond saturation point in job creation, and the private sector cannot pick up the slack.

The answer is in promoting small and medium-sized enterprises (SMEs).

The Egyptian-American Enterprise Fund is doing just that in Egypt with impressive results, qualifying it as a model that can be replicated elsewhere. If the right funding is allotted, such funds will not only create jobs for the youth but will also spare governments from having to subsidise masked unemployment through public sector jobs.

Moreover, it will help mitigate future risks from underfunded pension funds, another key issue for years to come. Now, what if SWFs and pensions funds got involved?

Those funds are, by the nature of their exposure, invested in both issues, and allocating bigger shares of their investment portfolios towards the promotion of SMEs will thus be in their best interest. Such an involvement by SWFs and pension funds is two-fold.

First, investments into SMEs should not only be towards growing them in scale and operations rather in establishing as many SMEs as possible. This will maximise job creation, resulting in lower youth unemployment, while at the same time increasing success rates of such SMEs growing into the corporations of tomorrow.

SWFs and pension funds need to think of this as venture capitalists do when they bet on new and innovate business ideas. After all, it is what propelled service sharing ideas such as Careem, Uber, and Lyft into existence.

Secondly, entrepreneurs need to be allowed future pension payouts. That does not necessarily mean that all owners of SMEs would like a secure pay in the future, which could defy the purpose of entrepreneurial adventurism. However, as SMEs mature and entrepreneurs move onto their next big idea, SME owners may be interested in such a secure future payout.

Though the most straightforward way to do this is by allowing contributions by owners, an alternative could be that a percentage of returns from investing in the SME is allocated to a special fund for the SME owner. This will serve as further encouragement for others to start their own SMEs, relieving pension funds from part of their future payout commitments.

The last thought that I want to leave you with: can SMEs resolve the problem of underfunded pension funds? (Hint: current investments for long-term rewards).