Guide to understanding how the new generational funds of the AFP will work

Chile’s pension system is set for its most significant transformation in over two decades with the introduction of ten new generational funds, replacing the current five multi-funds used by affiliates. The change will take effect on April 1, 2027, following the pension reform enacted in 2025. These new funds will group participants based on their year of birth, marking a shift from the existing model where individuals could choose their preferred fund according to risk tolerance. The regulatory framework outlining how these generational funds will operate was published by Chile's Pension Superintendence for public consultation on July 3. This draft regulation, which still allows for modifications before its final publication by September 1, introduces several new concepts previously absent from the AFP investment regime, including glidepath, growth assets, protection assets, benchmark, tracking error, and information ratio. Under the new structure, there will be ten distinct funds. The initial stage is designated for participants under 35 years old. Then, eight intermediate stages cover age groups in five-year increments. Finally, the tenth fund is reserved for those aged 75 and older. While participants will automatically be assigned to a fund based on their date of birth, they will retain the option to select which AFP they wish to remain affiliated with. Additionally, they can choose which generational fund will hold their voluntary retirement savings. The glidepath mechanism forms the core of this new approach. It operates on a lifecycle principle, reducing risk automatically as the participant ages. According to AFP Cuprum, the glidepath refers to the defined investment trajectory each pension fund follows over multiple decades, gradually decreasing risk exposure. The regulation sets a maximum ceiling for "growth assets," such as stocks, higher-risk debt, and alternative investments, which AFPs can invest in. This ceiling decreases with age. For example, younger participants (Stage 1) can allocate up to 90% of their portfolio to growth assets, which are aimed at achieving long-term returns. By the time participants reach 51 years old, this percentage drops to around 60%, and further reduces to approximately 29% for those aged 60 and above. The remaining portion must be allocated to "protection assets," which include domestic and foreign fixed income instruments. These investments aim to provide stability and safeguard accumulated savings. The pension reform also introduced a novel incentive system, allowing for rewards or penalties for AFPs based on their investment outcomes. Karol Fernández, executive vice president of the Chilean Association of Pension Fund Administrators (FIAP), noted that such a reward-penalty mechanism is unique globally. Some countries apply performance-based commissions, but these are uncommon. The Pension Superintendence outlined specific rules governing the implementation of these incentives. It established ranges for different asset classes, such as the proportion that can be invested in Chilean equities, foreign equities, bonds, and other categories, for each generational fund. These guidelines ensure that AFPs adhere to predefined parameters while managing their portfolios. The transition to generational funds represents a fundamental restructuring of Chile’s pension system. With the new framework in place, the focus shifts toward aligning investment strategies with the life cycle of participants, ensuring that risk levels decrease as individuals approach retirement age. This approach aims to enhance the security of retirement savings while maintaining opportunities for growth during earlier life stages. The regulation’s final version, due by September 1, will determine the exact parameters and thresholds for each generational fund. Until then, the proposed changes remain subject to potential adjustments based on public feedback and further analysis.