Fifteen Years of Defined Contributions: Assessing the Chilean Pension Experience

Abstract

In 1980 Chile switched from a state-managed defined-benefit pension system to a defined-contribution scheme based on individual capital accounts. The new system was further refined in 2002 with the introduction of five investment funds, with, allegedly, different risk-return profiles. The funds differ in their portfolio composition which is driven by strict minimum and maximum limits (mostly related to stocks and bonds), dictated by the regulator. We have examined the performance of these funds over a fifteen-year period looking at their returns and actual risk profiles, aided by three rank-order metrics. Unfortunately, our results are unambiguously distressing: while the regulator succeeded in creating five funds with clearly different risk profiles, their risk-adjusted returns as well as their cumulative (absolute) returns are completely at odds with the desired goal. In fact, during long stretches of time the funds exhibited a performance that was exactly the opposite of what it was intended: an indictment on the idea of controlling portfolio risk via asset allocation limits.