Asset management in the central and east European (CEE) EU accession countries has had a mixed year. Increasing wealth alongside the privately run state systems operating in most of the eight entrants have inevitably boosted assets, but the bond-skewed allocation strategies have proved more questionable.
Hungary has been the most dramatic example this year. According to the Hungarian consultancy FI-AD, whose database covers 90% of the local asset management industry, assets under management totalled HUF2,800bn (E10.5bn) as of the end of June 2003, a year on year growth of 30% in forint terms. Investment companies ac-counted for 38% of the assets, insurance companies and pension funds around 29% apiece, other institutional investors 2% and commercial companies 1%.
The second-pillar compulsory pensions market has been affected by key legal changes, notably the resumption at the beginning of 2003 of the compulsory element of membership, which was suspended in 2002, along with reduced options for leaving the system. Until the end of 2003 members under 30 years of age have the option to leave the system after a year, but most have not apparently exercised this option in 2003. In the second quarter of 2003 membership stood at 2.23m according to Hungarian Financial Supervisory Authority (HFSA), some 7,000 down on the previous year but 16,000 up on the previous quarter. Assets increased year on year by 46% to HUF482bn, largely because the individual contribution went up by 1 percentage point to 7% of gross salary. In 2004 it rises to 8%, the rate envisaged in the original reforms.
In the longer established third-pillar sector membership rose by 3.5% year on year to 1.203mn, while assets increased by 30% to HUF394bn. The outlook for the coming years is alarming, however, because of a provision in the original law allowing members to withdraw their funds after 10 years, albeit paying tax of 40%. “We’re concerned that a good part of the membership will withdraw most or all of their funds, in other words treating the pension fund as a 10-year deposit,” warns Peter Holtzer, CEO at OTP Fund Management. The finance ministry has introduced a tax exemption of four basis points on final payout for each additional year members leave their funds intact, although Holtzer doubts whether this will be enough. Given that employers paid up to 70% of third pillar contributions, most Hungarians are looking at their potential withdrawals - worth an average three months wages after the 40% tax – as a windfall, and on current trends, will spend it on consumption, while the liquidation of their portfolios will lead to massive sell offs in the securities markets.
At present these are the last things that either the Hungarian economy or investment fund industry need. High consumption is pushing Hungary’s current account deficit towards 8% of GDP, while net foreign direct investment is set to flow out, creating severe financing problems. Simultaneously the fiscal deficit could be as high as 6% of GDP. The Hungarian fund market is similar to other CEE countries in its high concentration of interest rate securities – domestic bonds accounted for 70% of the investment fund portfolio as of mid-2003, money market funds a further 21% – but is the most exposed to international sentiment because of the high percentage of foreigners investing in Hungarian securities.
The markets reached crisis point in late November when yields on sovereign bonds shot up by 200-300 basis points, forcing the central bank to raise its base rate by 3% on November 28; a similar hike had already taken place in June. Peter Holtzer blames the crisis on government mismanagement and miscommunication. He estimates that since late spring some HUF100bn has left the bond and money markets. “Equity funds, which should have benefited from the higher price rises in CEE markets, just saw profit taking so there has been no net inflow,” he adds. However, equity funds this year produced relatively stable returns of around 20%, while bond funds offered negative returns of 4-5% combined with massive volatility. “The only positive development from this crisis is that it showed that there are huge potential losses in fixed income, and that bonds are not always a safe haven.”
The one bright investment spot has been real estate – Hungary is the only CEE country with any significant property fund investment – where assets as of mid-2003 had doubled year on year to HUF50.9bn. Hungarian real estate prices are low by EU standards, and while the money and bond markets are currently described in Latin American tones, no one is forecasting a property collapse. “But investors are not well educated and do believe the ‘real-estate’ story,” Holtzer warns.
Poland faces similar fiscal problems to Hungary – its budget deficit is expected to exceed 5% of GDP in 2003, although its current account is in better shape - and consequentially a rocky second half of the year, including an additional sell off in late November sparked off by Hungary’s crisis. As the biggest of the accession countries – its population of 39m exceeds that of the others combined – it also has the biggest asset management industry. The compulsory pension funds (OFEs) alone had PLN42.77 (E9.1bn) of assets under management as of the end of October, the investment fund companies (TFIs) PLN34.75bn (E7.4bn). There is a less successful corporate-based third pillar programme and a new, fourth or ‘individual’ pillar due this year, under which citizens will receive tax incentives to save for their retirement in plans managed either by investment or insurance companies.
As in most of the investment funds in the region Polish government bonds have traditionally accounted for a good chunk of the business - 67% as of the end of 2002, followed by money markets at 18%, balanced funds (4.5%), domestic equities (4.4%) and stable growth (2%). The industry has grown at a spectacular rate, by more than 80% year on year in 2002 and nearly 60% in the first 10 months of 2003. “The first part of 2003 was driven by bond funds, as in previous years, because of the so-called bonanza of the Polish bond market caused by falling interest rates,” explains Zbigniew Jagiello, president of Pioneer Pekao TFI, Poland’s largest investment fund company with nearly 30% of market share. “This supported growth until July, after which were hit by the world-wide depreciation in the bond market, and also domestic problems such as the budget deficit. The second driver was the growth in securities on the Warsaw Stock Exchange, as well as growth in balanced and stable growth funds.”
Returns on bond funds have fallen from 3-4% in the first half of the year to 0-1% as of November, well below bank deposit rates as well as inflation, while balanced funds are yielding 10–15% and equity funds 20–25%. Since July money has flowed out of bond funds each month, changing the overall asset structure. As of October the bond fund share had fallen to 48%, stable growth funds – a voluntary pension-type product – had become the third highest sector after money markets with 12%, while foreign bond funds, which last year accounted for around 1.5% of the total, now rank fourth with 8%.
In the case of the OFEs, where bonds accounted for 63% of the asset portfolio as of end October, followed by equities at 33%, the problem is less of inflow – contributions flow in regardless in a mandatory system – than returns and asset allocation. By law the OFEs can only invest a maximum 40% of assets in equity and 5% overseas, so their options are limited.
There are some tax changes ahead that will affect the Polish fund industry. plans to charge capital gains tax on direct investment into Warsaw Stock Exchange equities will put stocks on an equal footing with investment funds and deposits, which have been subject to the tax since 2002, but may also depress stock prices in the short term. Of more concern is the proposal to levy VAT on asset management activities. “Investment funds are not subject to VAT in EU countries and the Association of Polish Investment Funds has put pressure on the government not to tax us,” adds Jagiello. There are no current plans to change the legal segmentation in Poland’s asset management industry – pension funds must be managed by their own investment department and cannot outsource, even to the investment fund management company in the same financial group – although Jagiello believes that in some two to four years’ time this restriction will be lifted.
The Czech market has remained relative insulated from Hungary and Poland’s market problems, despite its own economic troubles, including the largest forecast budget deficit in the region, because of the smaller volatile foreign portfolio interest. The Czech asset management industry includes a long established private pensions system with CZK73bn (E2.3bn) as of the end of September 2003 according to data from the Association of Czech Pension Funds. Parliament is discussing a draft law on second pillar pensions, but it has not decided yet whether to make the system compulsory. The investment and mutual funds industry has CZK147.2bn (E4.6bn) in assets according to combined data from AKAT, the Capital Markets Association, and UNIS, the Union of Investment Companies of the Czech Republic, again as of September 2003. The Czech funds market is unusual by CEE standards in its long tradition of foreign funds distribution. Of the 778 funds registered, 706 were foreign domiciled, although as a proportion of assets they account for only 28%. There is also a bias towards money market funds - these accounted for 44% of the market, followed by bond funds (28%), hybrid funds (18%) and equity (6%).

While investors continued to buy into interest-rate based funds in the first half of 2003 because of historically good returns. “A lot of people are now switching heavily out of bond funds into deposits instruments,” reports Josef Benes, CEO of CSOB Asset Management, the largest investment fund manager by assets. “One reason is that we’ve reached the bottom of the interest rate cycle and in the near term there is a strong perception that short and medium-term interest rates will rise.” There has, as a result, also been a renewed interest in capital guaranteed funds. Investment in CSOB’s capital guaranteed fund, launched two years ago, was initially muted because of the overwhelming preference for six-to-nine month instruments such as money markets and bank deposits, has suddenly skyrocketed, adds Benes.
Between the second and third quarter Czech domiciled investment fund assets fell by CSK8.4bn or 7.3%, while assets of foreign domiciled assets rose by CZK3.8bn or 10.1%.
Although retail investors, as elsewhere in the CEE, are the main buyers, certain short-term funds have also been used by companies as a cash management alternative to deposits. However, many sold off their holdings in advance of a law effective in October making domestic securities income taxable, with many turning instead to foreign-listed funds.
In neighbouring Slovakia, the turmoil in the Hungarian and Polish bond markets concerns the local industry although its markets again have a much lower foreign exposure. There is a voluntary pension system of four funds with SKR9bn (E219m) of assets as of the end of 2002. A second pillar pension system, compulsory for new labour market entrants, is expected in 2005. The investment fund market is significantly smaller than in Hungary, Poland and the Czech Republic, but it has also seen the biggest growth rate. Assets managed by the investment funds totalled SK33.9bn (E824m), a growth rate of 193% year on year, despite stagnating rates of returns in 2003. “However, people are looking past performance and the increasing volatility of the bond markets and may move into other products,” notes Martin Duriancik, portfolio manager at Tatra Asset Management, which has the largest share of Slovakia’s investment fund assets. Money market funds have benefited at the expense of bond ones because of the inverse yield curve, while equity funds languish because of shortage of domestic stock. “We don’t have funds dedicated to domestic equity but every large asset manager has a foreign adviser to manage foreign equities, and here the interest is growing,” adds Duriancik.
The Slovakian fund industry faces a testing period because of a new flat-rate 19% tax regime due in 2004, provided it was finally signed off by the end of 2003. Previously fund income was tax exempt for three years, and additionally the first SKR50,000 was exempt. The tax holiday will disappear, while the exemption ceiling is lowered to SKR20,000. “It should not have that big an effect once people get used to the new regime because bank deposits, insurance policies and other savings will also be taxed,” says Duriancik. As the law is not retrospective, asset management companies are expected to make a last-minute push to get people to buy funds under the old tax regime.
In the Baltic states the relatively new second-pillar pension programmes are driving growth asset management business. Regardless of the element of compulsion – membership is obligatory for those born on or after 1971 in Latvia and 1983 in Estonia, but totally voluntary in Lithuania – the schemes' popularity in the voluntary sector has been well in excess of initial government estimates.
Latvia has the longest established private pensions system, with the third pillar operating since 1998 and the second since 2001. The third pillar comprises five open funds and a closed one run for the fixed line telephone and electricity companies. The second pillar currently has six investment companies as well as the state treasury, which managed all the assets until the beginning of 2003, and which is used by those who do not trust the private sector; between them they offered 15 plans. Both sectors have grown robustly. In the state-funded second pillar scheme, where 19% of the total population had enrolled, assets as of September 2003 totalled LTV21.4m (E32.4m) according to the Financial and Capital Market Commission, a year to date increase of 74%, while in the private system they stood at LTV18m (E27.3m), a year on year growth of 41%.
The investment fund industry is of a similar size, LTV20.2m (E30.6m) in net assets as of mid 2003, up by 39% over the previous year, with eight open and six closed funds on offer. Even allowing for the small size of the local stock market, Latvia’s asset business is the most heavily bond oriented in the region, 68% for private pensions, 74% for the state system and a massive 97% in the case of investment funds.
In Estonia, where registration started in April 2002, more than 330,520 individuals or 56% of the workforce had signed up by the end of October. Assets under management totalled E49.1m against E5.1m for the third pillar voluntary pension programme that started operating in 1999 according to data from the Estonian Financial Supervision Authority (FSA), the fund industry regulator. The high uptake is notable because unlike most CEE second-pillar funds, which are financed by diverting a portion of the first-pillar state fund contribution, Estonian participants have to contribute an additional 2% of gross wages themselves in addition to a 4% diverted portion. “The second-pillar pensions are the fastest growing sector and where we are concentrating our resources,” notes Mihkel Oim, head of asset management at Hansapank, the country’s largest bank and fund manager. Providers can be either fund management companies or insurers, but of the six licensed managers, the investment arms of the three biggest banks, Hansapank, Uhispank and Sampo have cornered more than 90% of the market.
By law each pension fund manager, must offer a low-risk bond fund for older participants. Additionally the providers offer either one or two higher-risk funds with an equity component of up to 50%, and most participants are opting for these. Given the small size and share issues of the Baltic stock market, Estonia’s pension providers have no limit on their overseas investments. Oim notes that Hanspank’s strategy allocates 70% to overseas equities, and 30% to the ‘local’ market, which includes Latvia and Lithuania, and which this year was extend to the other EU accession countries.

As a proportion of total assets the pension funds are still small in relation to investment funds, but estimates project this market to reach E350m–400m by 2007. According to the FSA, by the end of September 2003 the fund industry’s assets totalled E446.3m, a year to date growth of 57%. Money market funds accounted for 54%, bonds 25%, the mandatory pension funds 11%, equity 9% and the voluntary pension funds just over 1%.
Investors have moved into money market and bond funds because bank deposit rates are low – just over 2% for kroon deposits in October and even less for euro ones – although equity and balanced funds have also grown this year. The bond funds are not the classic domestic sovereign issues as the government has tended to run budget surpluses but Estonian and Lithuanian eurobonds as well as some corporate issues. The biggest drivers have been companies using investment funds as liquidity management tools, says Oim. “Equity funds have also exceeded our expectations. Since 1999 the Tallinn Stock Exchange has had a double-digit performance, and a lot of foreign investors have started looking at our market.”
Lithuania’s asset management industry is set to explode in the coming years following the passage this summer of legislation for second pillar pensions and a new UCITS-compatible law on collective investments enabling mutual funds and similar products to be offered to the public. Pensions fund companies, which can be either investment fund companies or insurers, will start accumulating assets as of 2004. Meanwhile the take-up on this totally voluntary system, which unlike Estonia received relatively little government promotion, is some three to four times higher than originally envisaged. As of late November more than 308,000 had registered with up to 400,000 possible by the end of the year. The regulators have licensed 10 providers, between them offering around 30 plans, but a rapid consolidation is inevitable as the top two providers (respectively Hansa Investment Management and VB Investment Management, the asset management arm of Vilniaus Bank, Lithuania’s largest commercial bank) already have 60% of the market and the top four 90%.
The dominance of the banks and their branch networks over the insurers and their established sales teams contrasts with Poland where the opposite happened: the leader there is the Polish arm of Commercial Union. “We learnt from the mistakes in Poland and used both bank fixed premises and sales agents,” explains Saulius Racevicius, managing director and chairman of the board of VB Investment Management. The highest take-up has been in the 25–35 age group, with a balanced fund containing 20% equity the most popular plan currently. Like Estonia, Lithuanian providers must offer a bond-oriented low risk plan and optionally ones with an equity component.
No third pillar funds have been launched yet as the financial groups are concentrating on the second pillar. However, the savings culture stimulated by second pillar has spilled over into other products such as investment funds. Racevicius, who is also president of the Lithuanian Association of Investment Companies, estimates that there some LTL20m (E5.8m) against a total LTL120m (E34.7m) of Lithuanian assets under management. The larger Lithuanian banks, all foreign owned, are also acting as platforms for their parents’ funds. VB Investment Management, the largest distributor of foreign funds in Lithuania, sells a wide range of products from SEB, its Swedish owner.

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