The Swedish Premium Pension: Should an investor actively select funds or keep the default option?

Abstract: This paper examines the two alternatives currently available to Swedish employees for the investment of their PPM pension contributions. The aim of the study is to conclude which alternative is more beneficial: to actively select which mutual funds to contribute to or to passively invest pension contributions in the default option, Premiesparfonden. In order to achieve this aim, all registered PPM-funds as of October 2008 are analyzed, using the mean-variance framework developed by Markowitz (1952). This involves using a two factor asset pricing model and historical standard deviations for each fund. In addition, the concepts of utility certainty equivalent loss and return loss are used to determine potential losses of welfare, given the investor’s preferences. The impact of differing management fees between the two alternatives is analysed by altering the asset pricing model to take into account the low fee applicable to the default option. The findings reveal that few mutual funds yield a higher utility than the default option. In addition, any attainable gains are only marginal and the cost of finding these top performing funds is comparatively high. Furthermore, the investor’s utility and return are likely to be negatively affected by the choice to actively manage their pension contributions. Therefore, it appears that the default option is most beneficial for the majority of investors.