A pension fund is a specific investment fund for pension, this is the tool of retirement savings. It is an organization for collective investment, managing collectively funded pension and employee savings. Pension funds are supplied by the employee savings and often complemented by the companies.
A pension fund operates through:
- receiving payments (employee or employer) used to increase the capital, and in return the recipient will receive a share of capital (often called retirement points)
- receiving income from capital already invested and a portion used to pay management fees, the rest will grow the capital (but the number of shares does not change, only their value).
- disbursing pensions in the form of annuity, the number of points of the beneficiary is reduced due to competition, while the capital needed is sold as needed.
The pension fund owns and manages a portfolio of financial assets (stocks and bonds in particular). Variations due to capital purchases, sales and re-investment income, adds variations depending on the overall economic situation, booms (and bubbles) which increases capital gains.
A pension fund is a machine to make a double conversion .
payments (cash ) in long-term capital .
capital into an annuity .
The conversion mechanism is slightly different depending on whether the fund operates on the basis of defined contribution or defined benefit .
In the first case, the first conversion can be done easil : if the fund is valued at € 100 billion, and receives a payment of 100 € more. Its capital increases and it can give the participant a number of points equal to one billionth of existing ones.
But more complex formulas can be implemented to take account investment on the backdrop of improved profitability on a short placement. In this case, young participants receive more points (away from retirement, more working years ahead) and less for those closer to retirement.
Also in this context (defined contribution), the second conversion is more difficult because it takes into account the remaining life to assess the equivalent annuity of capital held .
If the fund is a defined-benefit , the calculation is carried out in the other direction : we start from the present value of an annuity that would be paid when the member retires, and asked an equivalent payment however, a reduced estimate of what the investment made with this payment will report .
We see that this calculation requires making assumptions very long term , it is more random, more risky and requires taking safety margins or to use the services (fee ) of an insurer.