Does it matter where investment capital comes from?

The fact that Dutch people and other Europeans invest relatively little is holding back economic growth and innovation in Europe. That point was recently made by ING Chief Economist Marieke Blom in comments to Dutch business news outlet BNR. But many Dutch people do invest, through their pension funds. So does it really matter to the economy whether investment capital comes from individual investors or pension funds? We spoke with APG Chief Economist Thijs Knaap.

Research conducted by Ipsos on behalf of ING, to which Blom refers, appears to confirm the view that Dutch people prefer to keep their money safely in savings accounts rather than invest it, even if that comes at the expense of returns and economic growth. Is that an accurate picture?
“Policymakers are currently considering whether Dutch people should be encouraged to put more of their money to work in the stock market. But in my view, Dutch people do not invest nearly as little as is often suggested. If you look only at household wealth, it’s true that Dutch households save a lot and invest relatively little. But once you take pension assets into account, the picture changes completely. Pension wealth represents a very large share of the total wealth of Dutch households. That also helps explain why people invest less on their own: much of that investing is already being done for them.

If you then look at what pension funds invest in, you see that a significant amount of risk is already being taken. Dutch pension funds have relatively large allocations to growth assets such as equities and real estate. When you combine that with what households do themselves, a substantial share of total wealth is ultimately invested in risk-bearing assets. In my view, enough is being saved and enough risk is being taken.

For the renewed pension system, we conducted extensive research into how much risk people are willing to take. The results show a fairly conservative risk preference, especially when it comes to retirement income. You can argue that taking more risk may lead to better outcomes over the long run. But most people simply do not want to spend their time actively managing investments. Pension funds do that on their behalf. Thanks to investment returns, roughly two-thirds of pension benefits can ultimately be financed. In that sense, this system may offer the best of both worlds.”

From an economic perspective, does it make a difference whether pension funds invest or individuals do?
“My answer is partly objective and partly based on value judgments. The objective part is that pension funds can do things individual investors cannot. As a pension investor, we can diversify the assets of the funds we work for much more effectively. An individual may own one house, but not a hundred houses. Individuals can buy stocks, but generally not infrastructure, private equity, or an airport. Large investors therefore have access to a much wider range of investment opportunities. We also do this full time. The average individual investor manages investments in the evenings or on weekends. It is much harder to achieve the same level of risk management as people who do this professionally every day.

At the same time, there is also a value judgment involved. Economists often believe in the wisdom of crowds: the idea that many individual investors together may make better decisions than a small group of professionals. In pension funds, investment decisions are ultimately made by a relatively small number of people. That means you lose part of that principle. So this is not a black-and-white issue.

When people invest on their own, they often prefer what they know. Economists call this home bias, a point Marieke Blom rightly raises. People may choose Dutch stocks such as ASML more frequently than you would expect. That is beneficial for the European economy because more capital is invested locally. Whether it is the best choice for those investors themselves is another matter. From a diversification perspective, usually not.”

If Europe wants more capital flowing to European companies, does the solution lie with individual investors or with Europe itself?
“While individual investors often prefer familiar investments, many large European investors prefer to allocate a significant share of their capital outside Europe. Economic activity tends to cluster in one place. After World War II, an enormous amount of talent, business activity, and investment flowed toward the United States. That is how ecosystems such as Silicon Valley and New York emerged. Network effects like these are not easily reversed.

At the same time, the United States is not exactly becoming a more attractive place to do business. Independent monetary policy, prudent fiscal policy, and predictable policymaking are not what they used to be. So far, the consequences have been limited, but developments can sometimes accelerate very quickly. That is a good reason for the European Union to move faster on measures that make investing in Europe more attractive.”

Does the choice between institutional and individual investors also affect how companies are governed?
“Yes, particularly when it comes to shareholder engagement. Many individual investors rarely make use of their voting rights. There is always a small minority that does, of course, but in general pension funds are much more active shareholders. As a pension investor, we actively represent the pension funds we work for at shareholder meetings. We engage with companies on their policies and hold management accountable. Sometimes that makes us difficult shareholders. But ‘engaged shareholders’ is probably a better description. If executives want to award themselves excessive compensation packages, for example, we may vote against them.

Pension funds represent the interests of their participants, but through active ownership they also contribute to the long-term health of companies. In doing so, they ultimately serve the interests of other shareholders as well. That is why I believe it is a good thing when a pension fund is among a company’s owners. Pension funds are supported by professional organizations that focus every day on investing and stewardship, and they tend to take a much longer-term view than many individual investors.”