Europe Wants to Protect Absent Minded Savers

IN BRUSSELS, THE DEBATE ON THE PAN EUROPEAN PENSION PRODUCT (PEPP) FOCUSES ON THE DEFAULT OPTION, I.E. ON THOSE SAVERS WHO ARE TOO DISTRACTED TO EXERCISE THEIR RIGHT TO SELECT AN INVESTMENT PORTFOLIO

by Claudio Tebaldi
Translated by Alex Foti

The European Parliament and the European Commission are currently engaged in the regulation of an EU-wide pension product conventionally called PEPP. An acronym for Pan-European Pension Product, it is freely transferable from one country to another that is part of the EU. The PEPP regulation identifies a common European norm that will regulate the individual savings plans that households and employees can stipulate in order to supplement social security pensions and employment-related pension funds.

It is a technical issue unlikely to generate mass interest, but before even the most attentive reader leaves, he/she should be forewarned that, like in a Pirandello play, the debate in Brussels rages on the default option. That is, on how to treat the silent majority of savers who, while signing on a PEPP, do not exercise the right to choose the financial instrument where their contributions should go.

In fact, surprising as it may be, there is ample evidence that small investors are inattentive about investment opportunities and often even unable to make financial choices that meet the minimal requirements of rationality. It is well-documented that such distraction costs dearly and feeds social inequality. In fact, absent-minded savers are concentrated among the youngest cohorts, and in the segment of the population with lower levels of education and income.

The oft-vituperated supranational institutions of the EU are therefore committed to guaranteeing the right to prudent and profitable management of retirement savings, even for the many unwitting individuals who sign a life insurance policy but do not give indications to intermediaries as how to invest their money. If you think that this problem does not concern you because you think you are a diligent investor, you should not overlook the fact that where the money of absent-minded savers goes is important for all those entrepreneurs who have good ideas and need capital markets to finance their projects. In fact, the PEPP regulation is part of the set of reforms to promote the Capital Market Union, i.e. the creation of a well-functioning European capital market.
 
A second topic of debate concerns the merit of actual investment choices. The analysis of the behavior of investors shows that in order to minimize the effect of their mistakes, inexperienced investors often choose to reduce their exposure and thus, fatally, their returns. On the contrary, also in light of an aging population and accelerating automation that depresses wages, today it is more necessary than ever to try to obtain higher returns.

Therefore, it is inevitable to increase exposure to market risk and at the same time use the usual diversification and hedging techniques that minimize the impact of negative trends in equity markets. Ultimately, the legislation that is in the process of being approved will have to provide incentives for market players to compete in offering the most technically appropriate products that meet those needs.

There are plenty of technical solutions available, and there are several opportunities that innovate traditional approaches to savings. The quantitative analysis carried out by the SDA Bocconi School of Management in a study commissioned by the European Financial Asset Management Association shows that, in particular, lifecycle funds (where the equity component is strong at the beginning, but decreases over the years) are a viable solution, since their yields are systematically higher than in the case of funds offering guaranteed minimum returns.