CHAPTERONE

INTRODUCTION

1.1          Background to the Study

Over the past decades, pension fund management and administrationhas received increased responsiveness in many countries (OECD, 2015). In recenttimes, policy makers in many countries have been attracted to pension as asource of an enabler for funded retirement savings by the maturing workforce(World Bank, 1994), opting for numerous forms of pension scheme. Nigeriaembraced the contributory pension scheme subsequent upon the pension reform of2004. In the contributory scheme, employers and theiremployees contribute a percentage of the employee’s monthly incomes to aretirement savings accounts from which they would after retirement draw theirpension benefits after retirement. Pension funds are currently amongst the keyinstitutional investment in the world financial and capital markets (Klumpes& Mason, 2000).

Pension FundAdministrators (PFAs) invest monies on behalf ofretirees in equities and other investment securities and assets to ensureincreased values.  They also savefor retirees, preserve assets, fund a pension plan and meet retiree’s spendingrequirements (Wallick, Julieann, Christos & Joanne, 2012). To meet thevarious needs of retirees or to ensure the performance of funds that is withinexisting regulatory provisions, PFAs adopt investmentdecisions and apply investment strategies or process, such as investmentstyle, asset allocation, risk profiling of funds. A good investment strategybegins with the right allocation of assets that achieves the objectives of theportfolio. The allocation must be centered on realistic expectations for riskand returns, and should use varied investments in order to do away with risksthat are avoidable (Davis, Francis & Glenn, 2007).

Investments involve risk,thus PFAs need to strike a balance between risk and potential return oninvestment through their selected portfolio holdings (Wallick et al., 2012). Itis unethical and improper to carelessly invest pension funds on bad orill-advised investment, because these are entitlement of workers at point ofexit (retirement time). Due to the volatility and sensitivity of the pensionsystem especially in a developing country like Nigeria, successive governmenthave initiated reforms so that most employees will avoid not having enoughmoney to cater for their retirement (Awosika, 2009). For these reforms, itbecame necessary that they discard old benefit schemes where government makesprovision to guarantee retirement benefits toward achieving a pay-as-you-goscheme that are either fully funded or partially funded, where risks are borneby contributors, and not the government (Amoo, 2008). The previously used schemelost its acceptability because of factors such as demographic developments,future liabilities that are unfunded, multifarious fiscal deficits and lowerbenefits for pensioners (Amoo, 2008).

The Pension Reforms Act (PRA, 2004) was created with contributionsfrom all stakeholders.  This act iscompletely premised on individual accounts which are held and managed privatelyby Pension Fund Administrators (PFAs). PFAs are financial institutionsestablished with the aim of accruing funds in order to meet projected pensionobligations of workers; they are saddled with the duty of devoting pensioncontributions to ensure that profits are made (National Pension Commission,2008). Thus, the bleak future of the retirees from public and private servicemade it paramount for policy formulators in the country to set up pensionfunds, which is contributory in nature, with part obligation on the employeeand part on the employers. The Pension Fund Administrators were licensed toproperly manage potential retiree’s funds.

The new pension schemeappears to be on firmer grounds than the previous ones, however for the fundsto perform excellently, it still largely depends on the investment proficiencyof pension fund administrators (PFAs) and investment strategies adopted by thePFAs. Despite the establishment of PFAs the process of selecting investment isstill complicated. On the average, investment selection have to go throughasset allocation (a method of determining how to allot an investor’s wealthamong different countries and asset classes for investment purposes) toStrategic asset allocation (which involves outlining and fixing portfolio assetallocations from the inception, based on historical performance data) andinvestment style (Chen, Gary& Kaplan, 2002; Reilly & Brown, 2012). Ifthis process are not understood and properly followed it will result in poorfund performance.

Anthony and Mustafa(2010) assert that investment decision is not just a mathematical selection ofexpected returns on various risk profile, but a whole range of factors – suchas political, economic, social factors. Despite the need to risk profile afund, it does not guarantee capital security or a level of performance. Risk profiling entails identifyingthe level of risk with respect to investment for a client, bearing in mind,required risk, the client’s ability and strength to accommodate risk, and thetoleration level for risk (Resnik, 2016). These concerns, along with numerousdynamics have enormous consequences on investment choices for Pension Fundadministrators. PFAs’ are entities that have the final say, in terms ofdecision making. The duty of pension administrators entails allocation ofassets, industry by industry, on a yearly basis to ensure that they get maximumreturns on investment benchmarks pre-assessed on a particular fund. Allocationof assets and investment style verdicts that are reached by handlers of thesefunds for a long-term basis, stand as the bedrock of what makes up theadvantages to plan members, and also help give form to the economy of a nationsubstantially (Tsado & Guru, 2011).

Fund managers can beinactive, that is, just buying and holding funds or passively indexing just toreduce transaction cost. On the other hand, fund managers can employ an activeinvesting strategy, a situation where they invest in a fund that is momentumtrading or “actively managed” (an attempt to outperform benchmark indexes)instead of duplicating market’s returns, as seen with index-tracking or passiveinvestment funds (Blankfein & Cohn, 2010). Studies have also shown that onthe average, active funds cannot beat the market, thus corroborating thefindings of critics (Malkiel, 2003). Some authors like Morey (2005), Morey& Gottesman (2006), Huebscher (2009), and Philips; Kinniry Jr.; Walker;Schlanger; Hirt (2015), found dissimilar outcomes onfund rating. Higher-rated funds were found to outpacelower-rated funds.

Furthermore, according to Reilly and Brown (2012) the highestcompounded returns from the broad asset class, such as  bonds, Treasury bonds, corporate bonds, andhigh-yield bonds, in the long run, will most likely accrue to those investorswith larger exposures to risky assets. The various moves made by PFAs, to makeinvestment in a certain asset class or otherwise hinge on different reasons andtheir significance (Tsado & Guru, 2011). Also, there is a division ofthought and experience in the world of investing, and there are studiessuggesting that both sides are right. However, there is also a division among practitionersas to which strategy is the best. There exists no backdoor or guarantees tobeing successful when it comes to investing, however, sustaining a realisticand methodical attitude to the art of investment may in some cases enhance thepossibilities of investment accomplishments as time progresses (Reilly &Brown, 2012).

For accurate managementof pension by Pension fund administrators (PFA), it is imperative that fundswhich are invested on behalf of the client (potential retirees), must toe theline of the best and appropriate investment strategy to enhance fund securityand performance. The Investment strategy adopted by the PFA goes a long way indetermining how successful they perform, otherwise retirees both from thepublic and private sector may face a miserable future (Ayegba, James &Odoh, 2013). This study intends to explore and investigate deeply, the impact,importance and extents that investment strategies go to in order to engenderfund performance.