Where is the capital of the 2nd pension pillar invested?
Your unit of the pension accumulated in the 2nd pension pillar is invested in securities with the aim of making a profit, and thus increase your pension capital. Investments are made by the fund manager in accordance with your chosen investment plan. If you will choose a more conservative investment policy, your contributions will be invested primarily in government debt securities and corporate bonds. If you will have chosen a more active investment policy, your pension capital will be invested in companies` shares. In its turn, if you choose a balanced investment policy, your funds, balancing the risks, will be reasonably invested in both shares and government debt securities.
In order to understand which investment plan to choose, you have to understand how the securities market operates, what kinds of securities exist, what are the differences among them, advantages and risks.
What are securities?
Securities are financial instruments with which are transactions carried out on the financial markets and which prove obligations or rights of some person or business towards another person or company. These financial instruments are called securities, because in earlier times all contracts, commitments, obligations and rights were drawn up on paper, but with increasing amount of transactions and the development of information sharing technologies, new accounting and billing methods were introduced. Nowadays shares is a commodity that often exist only in the electronic form and they are neither tangible nor can be seen, therefore they are called book-entry securities. Book-entry securities have the advantage that they can not burn; they can not be stolen or counterfeited. Also the parts of the investment plan exist only in the electronic form.
There are many different types of securities, which depending on their function can be divided into: equities that confirm ownership of property and debt securities, which confirm one counterparty`s debt obligations to the other party. The most known equities are shares and fund units, while the best known debt securities are treasury bills and bonds, corporate bonds and mortgage bonds.
What is a securities market?
The basic idea of the securities market can be compared with any market where “traders” (in this case the securities market participants) buying and selling a “commodity” (securities) in order to make a profit. The main purpose of the securities market is to invest the money in securities and to provide income for the use of those savings. In its turn, the stock exchange is a market place with its trading and settlement rules, creating the same conditions and ensuring the same opportunities as the market, so that the sale of securities could take place.
Securities market as any market forms on the basis of demand, supply and equilibrium price. The demand consists of securities issuers – governments, municipalities and companies who need additional funds for the implementation of some new project and who want to raise funds by issuing new securities. The supply represents individuals and companies who have built up the surplus money that they are willing to invest in the securities market and thus gain extra profit. In its turn, the equilibrium of prices must be such that satisfies both a buyer and a seller.
Why the securities market is needed?
When companies, state or local governments wish to obtain additional funds for the development of their activities, they issue new securities and sell them to the stock exchange. This is called the primary placement or public circulation. When the securities are alredy in the public circulation and the first securities owner wants to
realize them, he sells his securities to the next investor through a stock exchange. At this stage, the only benefited are the owners of securities.
Shares
A share is a security issued by a company to obtain additional funding to further development of its activities, new projects. Shares are the holder`s proof of owning the company`s property or part of the capital, and he is co-owner of the company who are entitled to receive dividends or other income.
Advantages by investing in shares!
- You can buy and sell shares in short term and gain profit from share price fluctuations;
- buying shares, you become a co-owner of the company, without the establishment of your own company;
- you can make long-term investments in shares, you have the opportunity to participate in the general meeting of shareholders, to raise some issue and vote, thereby deciding the future of the company;
- if the company has been profitable and the shareholders make a corresponding decision, the dividends are paid to you;
- you can buy and sell shares for cash, pledge, lend, donate, bequeath;
- the company`s operational time is not limited, so investment in shares is without time limit;
Debt securities – bonds, promissory notes, mortgage bonds
Debt securities are a proof of the loan with interests and other terms set forth already at the time of purchase of the security. For example, a bond is a long-term debt security (more than 1 year), issued by a state or a local government or a company, and for this loan the owner of the debenture receives some income, which can be divided into regular payments, or paid at the end of the period, along with the loan principal amount. Unlike bonds, a promissory note is a short-term (up to 12 months) security to be sold at a discount (below nominal value), but theat the end of the term the investor receives the full nominal value. Mortgage bonds are also a proof of the loan and the borrower the obtained funds disburse for loans for which a real estate serves as a pledge.
Investing in debt securities is considered a relatively safe investment, which may be suggested to an investor, who has excess cash for a longer period of time and who does not want to worry about changes in securities prices, as is the case of shares. During the entire operation period of the debt securities their owners can change, but the principal loan will get the one, who will hold the security at the closing date of the period. As the guarantee of safety that the loan will be repaid serves a property owned by a company, a municipality or state, as well as the stability of operation or business that provide with sufficient revenue to the issuer in the future. Investments in debt securities often give the opportunity to receive higher revenues as compared to bank term deposits, but lower than investing in the market of shares.
Advantages by investing in debt securities!
- Investing in debt securities provide income, the amount of which and timing of receipt is known to you already at the moment of making an investment;
- investment in debt securities is a good alternative to bank deposits because interest rates may be higher;
- promissory notes and bonds are liquid securities, they can be freely bought and sold, pledged, lent, donated or bequeathed. For comparison – if the money is invested in a bank deposit, but there is a need to receive it before term, it is not just lost interest, but for the breach of contract a penalty interest on the deposit principal amount shall be charged;
- you do not have to struggle to follow the securities market price, as income is defined already at the moment of purchase of the securities;
- it is a safer than investment in shares.
Investment funds and fund units
Investment funds are pools of money, where investors combine their resources to jointly buy shares, bonds and other financial assets. The money raised from the fund investors is invested in various securities with an aim to achieve appreciation of the invested capital amount. Investment funds allow investors to share the risks and costs associated with investment in financial markets, thereby gaining more income. For their investment investors receive fund units (investment certificates) in proportion to their contribution to the fund. Profit is usually acquired as a result of increase in value of fund units, but in other cases, in the form of dividends and interest. Investment fund`s aim is to reduce risk in transactions with securities and to promote investment of private savings in the securities market. Investment fund professional administration is ensured by investment management companies.
Investment fund units or investment certificates are securities issued by investment funds that one can buy and sell. They demonstrate the investor`s participation in the investment fund. People invest their funds in investment funds in order to increase their volume thanks to the global economic development, as a result of which prices of securities increase and hence also the value of the invested funds capital.
Advantages by investing in investment funds!
- Diversification or investment diversification; combining investments of many individual investors, in the investment funds significant amounts of money are accumulated that for relatively small investors make available virtually any financial market in the world;
- Investment risk is reduced by combining the individual investments and dividing them into different securities, economic sectors, countries and currencies;
- Commitment to repurchase – the investment management company is obliged to repurchase the fund`s investment certificates (mutual funds);
- Advantage – investment funds provide investors with economy of time and money, as it requires only one input. Buying and selling securities, funds make deals of large volumes, which can be concluded with more favorable conditions;
- Safety – investment management companies are subject to strict laws, in Latvia it is the Law on Investment Management Companies. Investment certificates of the fund are publicly traded securities. In Latvia, issues of investment sertificates are recorded in the Latvian Central Depository. The fund`s assets are kept separate from the investment management company and the custodian bank.
- Your investment performance is monitored by the securities market professionals, who follow the situation in the global markets and search for the most favorable investment opportunities for the money investment;
Issuers
By issuing shares, companies are able to raise new share capital for the development of their activities in order to more rapidly develop production, improve the company`s financial performance and extend the range of products and quality. As the company becomes more open, increase the opportunities for attracting new investors and easier loan receipt in banks. If the aim of company`s owners is taking over of another company, then the part of the purchase price can be paid by the acquiring company`s shares, but if the company`s owners want to sell their own enterprise, it is easier to assess it, if the company is a public joint stock company with a listing history. And, of course, shares` listing on a stock exchange is the indicator of company`s quality.
Investors
In the securities market the aim of any investor is to make profit, however, all the investors can be divided into two conditional groups: long-term investors who purchase securities for a long time, and gamblers who buy securities for a short period of time. These two groups are divided relatively because the difference is not only in time, how long they retain the securities in their possession, but also in the form of profit gain. Investors buy shares to gain influence over the company, to manage the company with their knowledge more effectively and make a profit from the core business activities. Gamblers acquire shares in order to sell them later at a higher price, gaining profit from share price fluctuations.
NASDAQ OMX Riga or Riga Stock Exchange is an institution that provides the infrastructure for securities trading, as well as the same market rules and equitable market information access to all investors. Exchange`s mission is to promote the country`s economic development by engaging in competition for attraction of capital to the Latvian securities market.
In order to enable the investor to receive full information and orient in each market situation, NASDAQ OMX requires the companies whose securities are traded on a stock exchange, to open all the necessary information and to publish it. At the same time, the stock exchange also monitors its members – banks and brokerage firms that make transactions of securities on the stock exchange.
Latvian Central Depository (LCD) performs functions of the central securities depository in Latvia – it opens securities accounts to LCD participants (banks and brokerage firms) and performs safe-custody of all book-entered securities, serves corporate actions, makes payments for securities transactions, as well as informs the owners of securities. According to the Financial Instruments Market Law of the Republic of Latvia, LCD administers all publicly issued securities in Latvia. According to the wish of the issuer LCD registers and stores also privately issued securities. LCD has settled correspondent relations with the central securities depositories of Estonia and Lithuania, as well as with the international payment system “Clearstream”.
Financial and Capital Market Commission is the body which monitors all securities market participants. The Commission`s task is to develop rules and regulations to be followed by securities market participants.
In the Latvian pension system task of the Commission is to monitor the fund managers of the 2nd pension pillar and custodian banks subject to the law and other legislative requirements, i.e. that the funds are invested in accordance with the investment rules. Financial and Capital Market Commission also carries out the licensing of fund managers and the state supervision and has the right to suspend or revoke the license issued to a fund manager, if there are any violations in their business activites found.
