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Mixed signals to market

Two smoke signals rising from the offices of the Portuguese government have perplexed Portugal’s asset management community. The first is a proposal to cut the tax relief on third pillar pensions, in particular the highly successful Planos de Poupança Reforma (PPR). Under the proposal, floated earlier this year by the former social security minister and current finance minister, António Bagão Félix, tax relief will be removed from new plans or to top-up to existing plans.
The second is the suggestion that the government may be considering incorporating the fully funded pension scheme of the Caixa Geral de Depositos (CGD), Portugal’s leading state-owned banking group, into the first pillar pay as you go (PAYG) system. This would mean transferring assets worth e2.5bn into the unfunded pension scheme of the civil servants social security scheme, the Caixa Geral de Aposentacoes (CGA).
This suggestion has prompted threats of strike action by the STEC and the SBSI, two unions that represent around 6,500 employees at the CGD. The unions are angry that the transfer of assets would mean that the real assets of the CGD would be added the ‘fictitious’ assets of the CGA and that the new pension regime would create a ‘climate of uncertainty’.
The aim behind both these moves is to bring Portugal’s public deficit below the 3% required by the EU Growth and Stability Pact. However, there are doubts among some in the asset management community whether this is the right way to go about it.
Leonardo Mathias, managing director of Schroder Investment Management in Lisbon, says: “It is the first time since third pillar products like the PPR were launched in the 1980s and 1990s that anybody has considered touching them. What concerns me more than anything is that after all the efforts that have gone into creating a system of incentivisation for third pillar pensions, taking away their fiscal advantages will send mixed signals to both the savings and the pensions markets.”
In the longer term, however, the prospect for funded pensions appears brighter. In June this year, Bagão Félix unveiled a plan that would create a second pillar complementary pension regime by diverting a proportion of social security contributions into private pension plans.
Under the plan, the government will set two earnings thresholds; a floor set at six times the minimum monthly wage (currently e365 a month) equivalent to e2,196 a month; and a ceiling set at ten times the minimum monthly wage, equivalent to e3,656 a month. People within these thresholds, that is, people earning between six and 10 times the minimum wage, can opt to transfer part of their social security contributions to a private pension. For people earning more than 10 times the minimum wage it is mandatory to contribute to a private pension
However, the number of people that will be covered by the new provisions will be small initially. Participation will be limited to employees under 35 with no more than 10 years of social contributions history. Bagão Félix himself has said that he expects only 10% of eligible employees – around 2,000 people – to opt for private pensions in the first year of the scheme’s operation.
Yet this is sending the right signals to the market, says Mathias at Schroders: “It is a positive change and a change in the right direction. Expectation was high and we were expecting something slightly more ambitious, but we understand that these kind of broad social changes take time.”
The new system will create new patterns of equity. The current social security system is universal and does not discriminate. The proposed system, as it stands, will discriminate against higher paid employees. Carl de Montigny, a retirement benefits consultant at Mercer Human Resource Consulting in Lisbon, says that changes will be necessary. “ It will require changes in the tax treatment of pension contributions. A someone on a low salary can contribute up to about 80% of their salary to a pension. A high earner, say someone on e10,000 a month, can contribute up to only e3,600 or 36% of their income. That creates inequity.”
De Montigny suggest that this will affect the way companies look at pensions in future . “If people get only 36% they will have to make it up in some way, in the way that they do in other European countries.”
“The expectation is that those that above the 10 times minimum wage ceiling will be provided with the right incentives to save for a future that is adequate to their standard of living.”
In the long term – 10 years or more – the most profitable market will be those earning between six and 10 times the minimum wage, says de Montigny: “Investment managers and pension advisers will certainly be looking at that market because in the long run it will provide some very interesting money.”
Other changes in government legislation affecting pension fund investment include the laws relating to property owners. Property is a mainstream asset class in Portugal and has been growing in importance. At the end of June 2004 average pension funds’ investment in property was over 12%. More than three quarters of investment is in commercial rather than residential property.
However, this may change. The government has relaxed its legislation relating to residential property to allow landlords to increase rents to more market-related levels. Bernie Thomas, senior actuarial consultant at Watson Wyatt in Lisbon, says this could increase interest in property investment generally. “Although I don’t think that’s going to have a dramatic impact on institutional investment, because institutions don’t tend to go into residential as such, there is going to be some sort of spin-off and an increased awareness and interest in property.”
Perhaps the most significant piece of Portuguese legislation affecting pension funds has been the law implementing provisions of the European pensions fund directive. This law required all pension funds to have specific investment policies in place by June 2003.
Indirectly, this has changed the way companies with pension funds regard their investment objectives in 2004. Rui Guerra, investment consultant at Mercer Human resources, says: “One doesn’t want to exaggerate but in some ways this has forced pension funds to pay more attention to risk. Today most of the pension plan sponsors are more conscious of the risks involved, basically because they were asked to define a specific strategy for their pension fund, and that has been an important issue within the market.
“Most of our clients already have an investment policy in place with specific objectives for the pension fund, and a strategy that recognises the liabilities of their pension fund and the risks that they want to take.
“What is seen now as the main objective for most of the companies is to have positive return. So 2004 will probably be seen as a year of consolidation, where people wanted to make sure that their return is going to be positive.”
Non-annualised returns for pension funds in the nine months to September this year were 3.3%, compared with 5.7% for the same period in 2003. But after three years of negative returns between 2000 and 2002, nobody is complaining.

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