As the chart shows, this significant growth in assets is due primarily to an increase in domestic equities and UCITS shares, as well as in foreign assets, which mostly comprise direct or indirect shareholdings. Domestic shareholdings increased by ISK 88bn and foreign shareholdings by ISK 247bn during the quarter. In all, the pension funds’ holdings in domestic equities and UCITS funds totalled ISK 1,051bn (14.4% of total assets) at the end of 2023, while their foreign holdings totalled ISK 2,739bn (37.6% of total assets).

Tailwinds in the markets

Although the pension funds have doubtless invested heavily in foreign and domestic equities and UCITS shares during the period in question, the jump in their holdings is due primarily to a turnaround in domestic and foreign stock markets. Equity markets were buoyant in Q4/2023. For instance, the MSCI World Index, which reflects developments in global equity securities markets, rose by 11% from end-September through the end of the year, and the OMXIPI  index rose by 10%. Reduced concerns about high inflation, rising interest rates, and a possible economic contraction in major advanced economies made their mark on global developments, and domestically, positive news about specific companies in the Icelandic market pulled in the same direction.

These favourable developments in the markets significantly improved Icelandic pension funds’ year-2023 real returns relative to the outlook in the autumn of that year. We have discussed developments and prospects for the pension system in the recent past. At that time, we expected the pension funds’ assets to be negative in 2023, for the second year in a row.

It is therefore gratifying to see that our estimates were overly pessimistic. According to estimates from the Icelandic Pension Funds Association (LL), the funds’ nominal returns totalled 8.5% in 2023, giving a real return of 0.5% net of inflation.  While this is surely not a record-breaking real return, it is well above the 3.5-4.0% negative return we expected last autumn.

The pension funds are long-term investors, as it generally takes decades for premiums to generate income for the pension fund members who paid them. In addition, inflows from premiums still exceed pension fund contributions and operating expenses by a large margin and are expected to do so for several years to come. This means that the pension funds have significant tolerance for short-term fluctuations in returns.

LL’s estimates show, for instance, that the pension funds’ real returns have averaged 4.1% in the past decade and 3.8% in the past five years, despite weak returns in 2022-2023. The pension funds’ long-term returns have therefore been somewhat above the required threshold of 3.5%, which is good news for current and future pensioners.

Will 2024 be more bountiful than previous years?

In the wake of headwinds in domestic and foreign markets, the outlook seems to be brightening. The steep interest rate hikes of the recent past appear to be at or near their end, and it looks as though foreign central banks, as well as the CBI, can start easing the monetary stance in 2024. At the same time, it seems increasingly likely that there will not be a major economic setback in the near future.

For instance, the OECD now projects global GDP growth at 2.9% in 2024. The OECD considers the outlook to have improved marginally relative to its November forecast and the inflation outlook for major advanced economies to have improved likewise. All else being equal, this should create a relatively favourable economic environment for key markets in equity and debt securities alike. In our newly published macroeconomic forecast, we took a broadly similar tone, although we expect GDP growth to be somewhat more muted this year. As a result, it is highly likely that the pension funds’ real returns will be stronger in 2024 than in 2023, and that Iceland’s pension fund system will continue to thrive.