According to newly published figures from the Central Bank (CBI), Icelandic pension funds’ total assets amounted to ISK 7,946bn at the end of September, or 176% of estimated year-2024 GDP. By this measure, few other countries are in Iceland’s league. Those that are include Denmark, Canada, the Netherlands, and Switzerland, which have similarly robust funds for current and future pensioners.
Pension funds headed for a good year
The third quarter of the year was a favourable one for Icelandic pension funds’ asset portfolios, with rising domestic and foreign share prices fuelling a surge in the funds’ total assets. The outlook is for the pension funds’ real returns to be in line with the average of the past decade, and above their actuarial benchmark.
On the whole, pension fund contributions paid into the Icelandic system are still well in excess of outflows for pension benefits and operating expenses. Nevertheless, net inflows explain only a small portion of the ISK 649bn increase in total assets year-to-date. Based on developments in the past few years, our rough estimate is that net inflows from contributions exceeded pension benefits and operating expenses by about ISK 70bn. This leaves around ISK 580bn, which can be attributed to price increases and returns on assets.
Equities prove bountiful in Q3
The lion’s share of asset growth in 2024 to date stems from the pension funds’ foreign assets, which grew by over ISK 400bn in the first three quarters of the year. As of end-September, they were valued at the equivalent of ISK 3,143bn, or 39.6% of total assets. According to the CBI’s Financial Stability report, the pension funds’ net foreign currency purchases in the first eight months of the year came to ISK 51bn, some ISK 17bn less than over the same period in 2023. Assuming that FX purchases did not take a quantum leap in September, we can conclude that about 85% of the rise in asset values is due to price hikes and returns on foreign assets.
In this context, it is worth looking at global share price movements, as equities and mutual fund shares represent the vast majority of the pension funds’ foreign assets. In the first three quarters of 2024, the MSCI World Index of share prices rose by 17%, and the pension funds’ foreign assets appreciated by nearly 15%. After adjusting for probable asset purchases and movements in the ISK exchange rate, we estimate the direct and indirect returns on these foreign assets at roughly 12-13% over this period.
Unlike in H1/2024, the domestic stock market generated handsome returns for the pension funds in Q3. In terms of the OMXI15, domestic share prices rose by nearly 7% in Q3, after falling by 6% in the first six months of the year. At the same time, the funds’ holdings in domestic equities and unit shares increased by ISK 77bn, or almost 8%. These assets were valued at ISK 1,090bn as of end-September, accounting for 13.7% of total assets.
Strong returns expected in 2024 as a whole
After two weak years, the pension funds look set for strong returns in 2024. Domestic equities have been buoyant thus far in Q4, with the OMXI15 rising more than 8% between end-September and 5 November. The MSCI World Index has sagged slightly over the same period, however. On the whole, yields on domestic bonds have developed rather favourably YTD, but it should be noted that a large majority of them are recognised at the original purchase yield in the pension funds’ accounts, and fluctuations in the market therefore have limited impact on the funds’ total assets as they are recorded in CBI data.
As is mentioned above, the pension funds’ assets grew by ISK 649bn in the first nine months of 2024, which translates to a year-on-year increase of 8.9% in nominal terms. After adjusting for probable net inflows, we estimate the funds’ real return on assets at just over 3% for the period, which equals an annualised real return of 3.8%.
If the situation evolves as expected, the funds will reach the 3.5% actuarial benchmark used to assess their assets and liabilities in the long run. This would be the first time since 2021 that they have reached that target.
The pension funds are patient investors, of course, and it will take many years for outgoing payments of pension benefits to overtake inflows from pension contributions. In spite of a two-year drought, the pension funds’ returns have been quite acceptable, on average, over the past decade or so. Their real returns averaged 4.1% in 2014-2023, for instance. This year could align reasonably well with that average.
