Baltic states go their own way
Pensions reform promises to boost the Baltic asset management business. With the main domestic institutional investors, the insurance companies, invariably managing their portfolios in-house, asset managers have had to rely on a handful of high net worth individuals and related investment business such as M&A and privatisation advice. For all the talk about pan-Baltic legislation and harmonisation with EU legislation, the three countries have developed their business in strikingly different ways.
Latvia is the furthest ahead in the number of pension funds, although the requirement for private pensions law to have at least three banks or insurance companies as shareholders will by its nature limit the players. Only three open-ended pensions funds have been licensed so far: Open-Pension Fund-Social Security owned by Parex Bank and the life insurance companies Latva and Baltikums Dziviba; Unipensija, owned by Unibanka (also the asset manager), Maras Banka and insurer Fenikss, and the Baltikums fund, owned by the life insurers Baltikums and Salamandra Baltic, and Saules Banka.
The Balitkums fund was the first to receive a licence, in 1998, and has since accumulated Lats80,000 (E145,000) under management. Unipensija received its licence in February 2000 with Lats400,000 in paid-up capital; as of end November; it had assets of Lats270,000 under management. Clients include Unibanka’s own employees and the fund had just signed an agreement to manage the pension of Latviajas Mobilias Telefons, Latvia’s largest mobile telephone company. Parex’s fund, which started operating in September 2000, which had reached nearly $700,000 by end-November, again included Parex subsidiaries such as the bank, insurance company and brokerage, as well as companies and some private individuals.
By size these are outstripped by the fund of Lattelekom, the country’s fixed-line telephone operator, which operates the only licensed closed-end private pension fund in Latvia. The fund, which started in 1998, is compulsory for all employees and as of end-November had combined assets of $7.5m. Management of the fund was outsourced at the end of 1999 to Suprema Latvia, the local subsidiary of the Estonian securities and asset management house. Closed-end funds are only suitable for large companies with more than 3,000 employees, explains Roberts Idelsons, managing director of Suprema Latvia. “Closed-end funds are not that cost efficient because you have to have your own administrative resources allocated to the company, which is not the case with contributing to open-ended funds, so only large companies can afford it,” says Idelsons. “On the other hand the benefits the company managers and trade union representatives can sit on the board and decide on investment policy and other issues.”
Latvia has also been the only Baltic country to set up occupational schemes, a fact due to a generous tax regime. Employer contributions up to 10% of the employee’s gross salaries are exempt from income and social tax (while companies in arrears on their social tax contributions are barred from setting up corporate pension plans).
In Estonia, by contrast, such contributions would be deemed taxable benefits. Estonia’s third pillar legislation came into effect in 1998, but only two private pension funds have been set up so far. Hansapank’s fund, launched in 1999 had e575,000 of assets under management as of the end of November. Uhispank launched its private pension plan in November while EFM Optiva Asset Management plans to do so in 2001. The latter, recently fully acquired by the Finnish insurance group Sampo-Leonia, will be using its parent’s life insurance network to distribute its products. There are other retirement plans on the Estonian market, principally defined benefit schemes and unit-linked plans offered by life insurers.
Estonia’s second pillar is expected to come into effect in January 2002, although it has still not been decided at what age level to make the schemes mandatory. The higher the age group, the greater the costs in funding the shortfall from the state scheme. The government does not want to repeat Hungary’s experience of underestimating the shortfall from the state scheme, which in Estonia’s case would amount to Kroons30bn– 50bn (e1.9bn–3.2bn) over 30 years. Regulations on who can manage the schemes -for third pillar funds a minimum 18 months of investment fund management in Estonia - may be widened to enable qualified foreign asset managers to participate.
With an investment fund law in place since the early 1990s, the asset management business is by far the most developed in the Baltics, with 17 investment funds as of the beginning of December, the most recent a mutual fund launched by Suprema Tallinn. Total funds under management are around e100m. The main asset managers are the subsidiaries of the three big banks-Hansa, Uhispank and Optiva-as well as Trigon Investment Management, LHV Direct and Suprema. Between them they offer a range of risk profiles of stocks and bonds with pan-Baltic, central European or wider coverage, from western Europe to Russia.
Hansa Asset Management’s Baltic Growth Fund invests in securities issued not only by Baltic companies but by firms with business ties to the region, for example subsidiaries. Its money market fund is weighted to instruments with credit rating averaging Baa2 on Moody’s criteria, while the fixed income fund, benchmarked against six-month deposits, is weighted at around Ba1.
The most popular are the money market funds, indexed to one-month Talibor (Tallinn Interbank Offered Rate), which are primarily used by companies as a short-term liquidity management tool. Redemption can be on T+1 or sometimes T+0 basis but with returns equivalent to three- to four-month deposits. According to Loit Linnupold, CEO of Uhispank Asset Management, corporations account for around 95% of his bank’s money market fund. “It’s an easy products to sell, with low risk,” he explains. Money market funds became even more attractive at the beginning of 2000 after corporate income tax having was abolished in Estonia
Indexing and benchmarking are not common because of the lack of suitable indexes, although Uhispank runs the Aripaev Index Fund, based on the eponymous business newspaper’s equity index, making it one of the very few passively managed funds in Estonia. The interbank index meanwhile is skewed by the liquidity requirements of Estonia’s two largest banks, Hansapank and Uhispank.
Institutional clients are generally charities, foundations and insurance companies, although the latter will generally manage their assets in-house or at a connected bank. Outsourcing is uncommon, and likewise the use of consultants, although the state treasury, should it start issuing debt to finance the pension reforms, as well as the Stabilisation Reserve Fund, which invests the country’s privatisation revenues, are potential sources of external asset management and consultancy.
In the pipeline are new types of funds. “We’re seeing the first interest in high-yield fixed income funds, while the sale of international funds is increasing here,” reports Johann Sulling, managing director of EFM Optiva Asset Management. “In five years’ time you will see Estonian-registered products for the local Baltic funds, as well as specialised funds.”
In Lithuania the asset management community remains small, with the main players VB Investment Management (the investment and asset management arm of Vilniaus Bankas) and Hermis Finansai, established following a management buyout of Hermis Bank’s investment business after its takeover by Vilniaus in 1999. Brokers also manage private portfolios. VB has for the last six months run a private portfolio now totalling around Litas 6m–7m (e1.7m–2m) in assets, which can consist of pools of, say, local fixed income or foreign equities. It also sells foreign funds, from its owner Skandinaviska Enskilda Banken (SEB), Bank Julius Baer and Raiffeisen. Clients include institutional investors as well as private individuals. Hermis focuses on private clients.
The small size of the Lithuanian asset management market is partly due to the lack of relevant legislation. There is an investment companies law, which allows for Sicav-type vehicles, although the tax regime is unclear, but not one on investment funds, while the pensions legislation has still to be enacted. Following general elections last October, much hope is being pinned on the new centrist coalition to prioritise these issues. From a stock market perspective, the government is debating scrapping capital gains tax. “The Litas1m–2m hardly covered the cost of administration for the government while the declaration process for investors was worse than the tax itself,” notes Marijus Kalesinskas, portfolio manager at VB Investment Management.
Pensions legislation is the priority however. The state system has run a deficit each year, benefits are routinely paid late, the average pension is only around $50 a month and working pensioners have had theirs reduced. A draft pensions law is now set for debate, which will have to go hand in hand with reform of the state system itself. One of the lessons of the Estonia’s pensions reform, which launched the third pillar before the second, is that it has only produced two funds so far. “Running a privately pension needs critical mass of funds,” notes Rolandas Sungaila, head of the international finance unit at Vilniaus Bankas and part of the bank’s pension fund working group. “It takes mandatory contributions to benefit employees and the pension fund business.” As far as funding the second pillar is concerned Lithuania, unlike Estonia, still has substantial assets to privatise, and these proceeds could be used here, Sungaila believes, particularly as many of the pensioners contributed to these companies formation in the first place.
Krystyna Krzyzak is a freelance journalist