ING OFE: Investing with your hands tied
Nina Röhrbein spoke with Grzegorz Chlopek (pictured), CIO and vice-president of ING PTE, Poland's second biggest pension fund (with assets of €11.4bn) about the challenge of operating as a large institutional investor in a highly regulated market
"Due to the size of the fund our strategy is generally a long-term one," says Grzegorz Chlopek, CIO and vice-president at ING PTE, the management company of ING OFE. "We focus on three long-term investment decisions: the allocation between equities and bonds, our expectations of the performance of Polish companies, and our interest rate expectations over the next six to 12 months. Based on these three, we develop an asset management approach."
However, the strategic asset allocation of ING OFE is restricted by Polish law. Foreign investments, for example, are limited to 5% of the total asset allocation. "Pension fund management companies also have to cover the additional costs, which arise from their international investments," says Chlopek. That means in most Polish pension funds, more than 99% of the assets are invested in domestic markets. Polish pension funds currently account for more than 30% of investment in all government bonds issued in the domestic market and they also make up a very large part of the free float on the Warsaw Stock Exchange (WSE).
Due to its relatively large size in Poland, ING OFE is active in corporate governance. "Our portfolio comprises more than 50 companies in which we have more than 5% voting power at the shareholders meeting," says Chlopek. "We use our votes to represent shareholder interests."
Polish pension funds are also limited to an equities exposure of 40%, leading to an average equity allocation of 31-33%.
At the end of 2009, ING OFE was 65.5% invested in Polish government bonds and 32.2% in Polish equities. "These are our two most important asset classes," says Chlopek. "However, since the crisis we have become increasingly interested in different asset classes, such as corp orate, municipal or mortgage bonds. We started building an exposure to non-government bond securities, for example. Due to their low issuance and high demand their spreads had been unattractive in the past. After the crisis though, when interest from banks subsided, spreads widened and we started buying them."
By the end of March 2010, ING OFE reduced its allocation to Polish government bonds to 62.2%, while its exposure to equities had risen to 34.1%, and its non-Polish government bond allocation rose to 1%. But this change from December 2009 was mainly connected to fluctuating prices rather than an active strategy. "Fluctuations in the market always affect Polish pension funds very strongly," says Chlopek. "During the height of the bull market in 2007, all Polish pension funds were invested in equities close to the investment limit of 40%. By the bottom of the market in the first quarter of 2009 though, this had dropped to an average exposure of 19%. ING OFE took an active approach again very quickly and rebuilt its equity portfolio."
From a risk management point of view, the most important issue is the guarantee. The fund only takes risk when it is acceptable with regard to the guarantee. "But because it is a three-year guarantee we can still have a long-term investment strategy," says Chlopek. "Of course, the risk is highest when long-term rates of return are low, as they presently are."
ING OFE managed to achieve a return of 13.84% in 2009, beating the average Polish pension fund return by 18 basis points. Since its inception in 1999 it has generated an average annual weighted return of 10.95% compared with an average weighted Polish pension fund return of 10.33%.
The abolition of investment limits was discussed by pension funds such as ING OFE with the Polish ministry of finance three years ago, according to Chlopek. However, an amendment to the Polish law in 2009 exclusively concentrated on pension funds fees. Another unresolved problem is the lack of a multi-fund system.
"At the moment, we are managing one and the same fund for young employees as well as employees approaching retirement," says Chlopek. "The best solution would be to establish at least three funds: one with a larger share of riskier assets for young employees, a balanced one like we have at the moment, and a safer fund built on government bonds aimed at employees approaching retirement. But the Polish ministry of labour is not paying any attention to this problem at the moment."
"We also need to find more efficient investment solutions," says Chlopek. "Apart from the restrictions on international investments, at present, we cannot hedge any currency risk or make use of derivatives. This issue has now been passed onto the European Commission, which will take a decision on this soon. But in Poland itself the discussion is long and drawn-out, particularly as it is difficult to prove that, for example, long-term equity investments are more profitable than investments in government bonds.
Politicians want a permanent guarantee that they will always deliver. They do not recognise that for pension fund investors, the worst-case scenario is not a huge drop in the financial markets - it is high inflation over the long term. Safer and less volatile bond funds tend to have positive returns but in real terms are not a very good investment approach during periods of high inflation."
The latest amendment to the pension fund law decreased the entry fee of Polish pension funds. At the same time it also capped the management fee, which now applies only to pension funds that have less than PLN45bn (€11bn) of assets under management. "For the two biggest pension funds in Poland, this presents a problem as we are not able to collect higher management fees," says Chlopek. "Without any additional pay-offs or rewards, pension fund management companies will have to concentrate more and more on the risk than on the performance, which is not necessarily very effective for improving investment performance in the long run."