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Pension funds are losing billions annually due to end of month trading

Date:
June 30, 2015
Source:
Université du Luxembourg
Summary:
Pension funds around the world could be losing out on billions of euros and dollars of the stock market gains they would have made because they are obliged to sell part of their portfolios before the end of each month. Researchers found this phenomenon to be widespread across 26 stock markets from 1980 to 2013.
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Pension funds around the world could be losing out on billions of euros and dollars of the stock market gains they would have made because they are obliged to sell part of their portfolios before the end of each month. Research at the Luxembourg School of Finance (part of the University of Luxembourg) found this phenomenon to be widespread across 26 stock markets from 1980 to 2013.

"Pensioners generally receive their pension payments at the end of each calendar month, and this can cause problems for the fund," said Dr Kalle Rinne, one of the researchers on this project. Often interest and share dividends received by pension funds are not sufficient to cover the monthly payments they need to make to pensioners. Hence the funds may be obliged to sell assets towards the end of the month and then reinvest at the start of the next month. Thus the supply of shares is higher at the end of the month (depressing prices) and demand is higher at the start of the month (increasing prices). "This variation was enough to cause funds to lose a substantial part of the gains they make each year on the stock market," explained Dr Rinne.

The research found that, on average, over recent years institutional investors in the US that need to sell at the month end (principally pension funds) lost around USD700m of their annual gains due to this phenomenon. So for example, a pension fund might be in line to make 10% a year on its investments from dividends and rising stock prices. However, because of the need to sell to meet payment obligations, this could be reduced to 9.3% on average.

Our public and private sector pension savings (valued at USD25 trillion in the OECD in 2014) account for about half of total assets on stock markets. The size of the pension investment market has grown substantially in recent decades meaning the "liquidity" problems highlighted in this research have become stronger.

However, this phenomenon may be suspended at the moment. "This effect became particularly severe during the 2007-2009 financial crisis and continued until at least the end of 2013 when our study data ended," noted Dr Rinne. "However since last year extremely low interest rates mean pension funds are now able to borrow to meet their short term needs, so avoiding the cost of having to sell and buy assets," he explained. Low interest rates have also enabled financial traders to borrow to buy when prices are lower and sell at the start of the following month. However, when interest rates return to normal, maybe pension funds will need to change the way the pay out to policy-holders.


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Materials provided by Université du Luxembourg. Note: Content may be edited for style and length.


Journal Reference:

  1. Erkko Etula, Kalle Rinne, Matti Suominen and Lauri Vaittinen. Dash for Cash: Month-End Liquidity Needs and the Predictability of Stock Returns. (Working paper), 2015 [link]

Cite This Page:

Université du Luxembourg. "Pension funds are losing billions annually due to end of month trading." ScienceDaily. ScienceDaily, 30 June 2015. <www.sciencedaily.com/releases/2015/06/150630100702.htm>.
Université du Luxembourg. (2015, June 30). Pension funds are losing billions annually due to end of month trading. ScienceDaily. Retrieved May 28, 2017 from www.sciencedaily.com/releases/2015/06/150630100702.htm
Université du Luxembourg. "Pension funds are losing billions annually due to end of month trading." ScienceDaily. www.sciencedaily.com/releases/2015/06/150630100702.htm (accessed May 28, 2017).

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