The Bare Bones of a fund offering

Do we really need 867 funds or can we achieve the same diversification with just a handful. If that’s the case, what kind of handful should that be?

I had the privilege of spending July at the Swedish Pension Authority.

This was part of a Swedish Government sponsored evaluation of the Premium Pension system, you know that defined contribution scheme with the orange envelopes that was introduced in 2000, encouraging you to chose investment funds for a portion of your pension portfolio.

Today I was invited to share with them what I had found.

Check out the pdf file at the end of the post for the details

Two questions and three answers

Two questions:

1. Can the fund offering (867 funds) in the premium pension system be simplified and still offer the same amount of variability? I.e. Can we identify a number of building blocks that constitutes the fund offering?
2. If yes, which building blocks are of most interest among the pension plan participants?

Three answers:

1. Over 90% of all variability in the 867 funds can be replicated by 7 fund factors
2. Over 94% of all allocations were directed to these seven factor
3. It appears that the amount of funds in a category affects the demand for that category. I.e. a fund category with many funds appears to attract more money.

The results in a nutshell

A Principal Component Analysis followed by a Factor Analysis identify the seven fund factors or building blocks as:

There are four equity categories: Developed Markets, China & East Asia, Russia & East Europe and Japan

There are three Fixed Income categories: Developed Markets, Swedish long-term and Swedish short-term.

These seven categories have attracted between 94-99% of all allocated premiums over time.

Here we can see how premiums have been allocated to factor one (the top blue line) and the other six categories.

and here we can see the combined allocation to the seven identified fund categories. Between 94-99%

Have a look in the pdf for more details.

Stenkrona – Evaluation of the Swedish pensionssystem 29aug17