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Impact Investing

IPE special report May 2018

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Bringing in the euro

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  • Bringing in the euro
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Some Cypriot funds have been using this year’s euro accession to professionalise their portfolios, finds George Coats

Although it is not yet half way through, this has been a busy year for Cyprus. It opened with entry into the euro-zone. And election a month later resulted in the installation of the first left-of-centre president.

The run-up to euro entry had already had an impact on the pensions industry. “It put an end to a long period of high interest rates, which means that cash no longer provides a risk-free, comfortably-above-inflation investment,” says Christos Akkelides, director of asset management at Argus Stockbrokers Ltd, which undertakes asset management for second pillar provident funds. “So the funds have to seek returns elsewhere.”

“It has made investment much easier,” says Marinos Gialeli, (pictured right) general manager at the Cypriot hotel employees’ provident fund, the largest private sector fund. “We see euroland as a domestic market and that makes it easier for the trustee committee to accept changes in the portfolio.”

But not all see it as a turning point. “It has broadened investment horizons,” agrees Christos Spanos, executive director, advisory, at XS Capital. “Increasingly they are looking at euro-based assets. But having said that, the adoption of the euro has had a relatively small impact. What really kicked off the changes was the common platform with the Athens stock exchange when all Cyprus stocks started trading in euros about 18 months ago. And people started converting their Cyprus pounds into euros for investment.”

Akkelides agrees that the key catalyst for change to the pension landscape pre-dated euro entry but he still sees it as coming from Brussels. “The driving force behind any change was the legislation to implement the EU directive, which came into force in November 2006,” he says.

“That has had the most significant influence on the pensions industry since independence because it has forced local institutions - provident funds - to seek professional advice to diversify their portfolios overseas and to allocate more money to non-interest-related products, non-cash and fixed income products, primarily equities and alternatives.”

However, although the EU directive has been enacted, the majority of pension funds are too small to be affected by it. Cyprus has two types of pensions vehicles, provident funds, which are DC and provide a lump sum, and pension funds, which may be DB and provide on-going payments.

“There are about 60 pension funds, and some are the biggest on the island, but not a lot of provident funds fall into the over-100-member category,” says George Psaras, managing actuary, social insurance, pension and provident funds at regional actuarial consultancy Muhanna & Co.

“The issue for provident funds is that they have fewer requirements in terms of investment regulation compared with pension funds. Whereas a person in a DB scheme expects at the age of 63 to get 30% of their final salary from social insurance and knows they’ll get another 50% from the scheme, provident funds do not see their role as providing a replacement income at retirement. So they tend to get lower investment returns and are not required by law to get more or hit a target rate.

A provident fund member will contribute 5% of their salary, which their employer will match, but they will never have been given advice about the lump sum they could expect to get and what is the percentage of their income they need to retire. Needless to say the lump sum lasts for three years because they spend it, using it to repay loans, for example.”

“Plan sponsors have been trying to ensure that they do not have too volatile returns because then somebody who leaves in, say, 1995 could have very different benefits from someone who leaves in 2000 and that’s when problems start,” says Spanos. “But other than that they haven’t really attempted to optimise return within acceptable risk criteria, but rather preferred to try to completely eliminate risk.”

And provident funds allow all benefits to be taken at any time, without penalty and tax free, whenever a member changes job. “This makes talking about long-term investment strategies inappropriate because often the horizon is not very long,” says Philippos Mannaris, (pictured left) head of the Hewitt office in Nicosia. “And there is also no framework for converting lump sums into an annuity.” Only a small percentage of retirement plans are actually used for retirement, he adds.

 

Akkelides feels that the answer does not lie in legislation. “It will be regulated by the market,” he says. “Provident funds are generally constructed to accept single employee contributions which means that a mobile young professional has to take out his personal retirement money when he changes job.

However, this is different with some industry schemes like that for hoteliers. So the solution may be the growth of industry-wide funds and provident funds with more open architecture so a member will be able to maintain his provident fund irrespective of where he is located, what job he is doing and who the employer is.”

Spanos is not so sure: “The suggestion that funds might merge has been out there for a long while, but it is not easy to do,” he says. “Companies that feel they have done a much better job than others are not keen. And the EU directive is a sort of disincentive to mergers. A lot of plan sponsors have said ‘let’s adopt the philosophy of the directive but let’s not get ourselves over regulated’. So why should they go over 100 people?”

But does the new president, Dimitris Christofias, leader of Cyprus’ communist party, AKEL, like other left-wing European leaders support the primacy of the state pension? And what is the view of his administration of private pensions?

“The government does not object to the creation of second pillar schemes,” says Psaras. “After all the provident funds were created because of trade union pressure.”

“The government is a loose coalition between AKEL and the previously governing party, DIKO, and it has indicated that it would move ahead with the last government’s pension reform proposals,” says Mannaris. “But unfortunately these only focus on the first pillar.”

Indeed, last month labour minister Sotiroula Charalambous announced a package of measures that she said would ensure the state social security fund’s viability until 2050. The measures included a gradual increase in contributions of 9.1% over the next 30 years, stricter eligibility conditions for benefits and a review of the investment strategy. She added that she hoped to table legislation by the end of this month.

But for those funds that are big enough the way forward is through applying the directive’s requirement that they appoint advisers.

“The new legislation demands that a board of trustees takes expert advice where it lacks experience and we have seen that happening with the largest schemes,” says Mannaris. “The trend to employ investment advisers to advise them on strategy and the selection of fund managers has picked up over the last year.”

The Cypriot hotel employees’ provident fund is leading the way. It hired Hewitt to help design the investment strategy it is now implementing, which includes the appointment of Schroders and Edinburgh Partners to handle its global equities, BlackRock and Goldman Sachs Asset Management for global bonds and three local managers for local equities.

“A lot of other pension funds and provident funds follow our steps, hiring investment managers, trying to implement an investment strategy,” says Gialeli. “Already some are thinking in a much more professional way.”

One of those is the pension fund of the electricity authority. “We at are in the process of establishing our investment policy, but it is not yet finished,” says Stelios Constantinides, financial accounting manager at the Electricity Authority of Cyprus. “Hewitt advised on the new investment policy and we have sent RFPs to Morgan Stanley, BlackRock and Goldman Sachs, and we are in the process of assessing the offers. I anticipate that we will have concluded the process within the next few weeks.”

Additionally, Mannaris sees the 2006 legislation as opening up further prospects. “The cross-border provisions of the directive have been implemented in local legislation as well,” he says.

“It offers an opportunity for Cyprus to act as a hub for pan-European pensions, not for the whole of Europe perhaps but for a select number of countries in the region. Currently, there is movement from us and other market participants to register cross-border plans given the favourable legal and tax framework in place. We are testing the ground to see whether this could be an opportunity for multinationals based in, say, Cyprus, Greece, Romania and Bulgaria.”

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