Polish pension funds are not using their freedom to invest more in equities, finds Krystyna Krzyzak
Poland's second pillar pension funds (OFEs) suffered a double blow in 2011, with lower contributions and falling equity prices cutting asset values. In May 2011, contributions to the funds were cut from 7.3% of gross wages to 2.3%, with the shortfall retained by Poland's Social Security Institution (ZUS), which administers the first pillar.
These were initiated to stem the budget deficit and keep public debt within Poland's internal ceiling of 55% of GDP. The OFE contributions cuts, equivalent to around PLN9bn (€2bn) in 2011, have made a significant dent in the public sector's estimated PLN60bn deficit for the year, as well as reducing the government's bond issuance. The additional sums now retained by ZUS are to provide a return based on the preceding five-year average rise in real positive GDP. "This is a dubious guarantee passed on to future citizens," says Warsaw School of Economics's Dariusz Stańko, external advisor to the Polish Chamber of Pension Funds. He cites demographic projections that see the numbers of working age citizens supported by a labour force of 1,000 rising from 261 in 2010 to 437 by 2030 and 683 by 2050. "Without some dramatic labour productivity changes, the government has traded off no tax increases now for future taxes," he warns.
Recent Polish government attitudes towards the privately managed second pillar have never been as draconian as those in Hungary, and the governing Civic Platform (PO) overruled its minority Polish Peasants Party (PSL) coalition partner in not freezing OFE contributions altogether. Nevertheless, the May 2011 law followed on from the previous cuts in the fees charged by the second pillar companies (PTEs), and a long-standing policy of reducing market concentration. The three biggest funds, run by ING, Aviva and PZU, account for 60% of assets and 51% of total membership. The 2010 reduction in fees included a cap on management fees for assets above PLN45bn, which affects the two biggest funds, ING and Aviva. "We stopped selling the funds back in 2010 because of the management fee reduction," reports Marcin Żółtek, board member and chief investment officer at Aviva BZ WBK pension fund.
With the second pillar compulsory for those born after 1968, OFE membership continues to grow, reaching 15.5m in October 2011. Employment has remained stable at 9.9%, close to the EU average, while the economy has proved resilient, with the country being the only EU member to escape the 2009 recession. The OECD forecasts 2011 real GDP growth at 4.2%. Economic weaknesses include a marked decline in the value of the złoty against major currencies and its impact on the high share of Swiss franc-denominated personal finance. (By August 2011, the złoty had lost some 40% of its pre-2008 value.) The high foreign ownership of the bank sector is raising concerns about parents withdrawing from the market to protect their own capital base. In November, Moody's downgraded its outlook on the Polish banking sector from stable to negative, while the OECD cut real GDP 2012-13 growth forecasts from 3.8% to 2.5% because of weak external and domestic demand. Exports remain vulnerable given that EU accounted for 78% in the first three quarters of 2011, the euro-zone 54%, although Poland is less dependent on these than other countries in the region because of its high population and consumer market. Despite the relative strengths of the economy, Polish pension fund assets were hit by last autumn's global stock market collapse, with net assets declining by six percent between June and September 2011.
Alongside the contribution cuts, the 2011 changes raised the 40% equity limit by two-and-a -half percentage points a year to 62.5% by 2020, eventually taking it to 90%.
In 2011, there were no takers for the year's higher limit, with the average equity share declining from a peak of 37% in April to 31% in September. A slight recovery in October increased the share by one percent. "The main Polish equity index WIG has delivered a 20% loss so far this year, while Polish government bonds returned around 5%," explains Andrzej Sołdek, president of the board at PZU pension management company. "Polish government bonds and local equities are, by far, the biggest components of our fund as well as our competitors'. As the equity allocations exceeded 30% during the whole year the rates of return are negative across the board."
By regional standards, the OFEs remain big equity investors. According to the Warsaw Stock Exchange (WSE), they accounted for 21% of domestic investor turnover in the first half of 2011; investment funds accounted for 33% and market makers 29%. Grzegorz Chłopek, vice president and chief investment officer at ING PTE says that unlike the falls of 2007-09, price-to-book value ratios are lower, enabling funds to buy assets cheaply.
Nor are equity shares of Polish pension funds likely to reach the levels envisaged by the legislation. This is partly because of the minimum guaranteed return: management companies whose funds generate a three-year averaged return less than half of the average must make up the difference from their capital. At the PZU (which held 32.8% of its assets in equities in October), Sołdek notes: "Obviously, the increasing equity allocation limit will be one of factors influencing our investment decisions going forward. On the other hand, the existence of ‘minimum required rate of return' discourages from increasing equity weightings as they are characterised by higher volatility, so high allocation to stocks increases the risk of surcharge."
Other debt securities also suffered. "The biggest change was in the corporate debt market. The appetite was reduced, as pension funds became more cautious about investing in illiquid instruments", notes Aviva's Żółtek. "A good indicator was investment in government-guaranteed road bonds, which have been mainly bought by pension funds. In the last two auctions the demand barely met issuance, which previously had been oversubscribed."
Overall the funds increased maintained a high, 52%, allocation to Polish bonds in 2011, although these assets took a hit after Hungary was downgraded by Moody's, this despite Poland being stronger economically. "Polish bonds did prove quite resilient to market disturbances, and being long Polish bonds between April and September was a good investment strategy," observes Żółtek. "Now it seems that instead of Polish bonds being a safe haven, there is a contagion effect."
ING's Chłopek adds that, with good GDP performance and an improvement on the budget deficit, Polish bonds have remained relatively stable, with the yields on 10-year bonds falling to 5.94% at the start of December 2011, a drop of 0.11% in the year. He does, however, point out the paradox that the government, as a result of steering the pension funds towards equities, is becoming increasingly reliant on foreign rather than domestic institutional purchasers. "Consequently, the government will have to prepare more restrictive budgets to give comfort to foreign investors, sell in difficult times and refinance future needs," he explains.
Foreign diversification has been close to impossible because of a long-standing 5% limit on foreign investment. Since the start of 2009 the average investment did not even reach 1%, and by the end of October 2011 was a meagre 0.5%. The foreign investment limit is accompanied by additional barriers, including a requirement that any security has an acceptable credit rating. Costs incurred in foreign purchases must be borne by the management companies themselves. The minimum-return guarantee also hinders taking foreign risk, and since the funds are prohibited from using derivatives, they cannot hedge against currency flucuations. "The of use of derivatives could be positive. It would increase the investment strategies we can use, giving our managers more flexibility," says Sołdek. "Specifically, it would allow us to gain exposure to the price of financial instruments without taking FX risks."
The Polish pension funds have been able to introduce some proxy foreign diversification through the overseas company listings on the WSE. As the biggest, and most liquid, exchange in the region, the WSE is used by regional companies for their primary listing, with the start part of 2011 dominated by Ukrainian listings. The WSE plunge had a big impact on the exchange's IPO business, with a number cancelled, while the pension funds backed off according to Marcin Żółtek. "Polish pension funds are no longer buyers for every company seeking a dual listing, but are much more selective," he says.
This story first appeared in the January issue of IPE magazine.