Cyprus: Stepping off the path
Nina Rohrbein looks at the effects of Regulation 2/2010 on the conservative asset allocations of Cypriot pension funds
Traditionally, most Cypriot pension funds have been conservative in their investment approach. The bulk of their assets are in cash, or allocated to fixed deposit accounts with banks. This attitude did not change much during 2009, leading to restrained annual returns of between 6-9%, according to Philippos Mannaris, head of the Hewitt office in Nicosia.
"The funds that had exposure to European or global equities achieved a 20-30% return from these portfolios," he says. "However, this needs to be put into context of an average 10-15% allocation to equities."
High interest rates of 6-7% for local 12-month deposit accounts also meant that pension funds were reluctant to take any risks in 2009. "Over the course of the last couple of months though funds have not been able to renew their fixed deposits at similar high rates," says Mannaris. "That is why they have begun to ask questions, revisit their strategies and seek that extra return."
A new approach to investment is also being encouraged by the supervisor's Regulation 2/2010, which came into force on 22 January 2010, and concerns the prudent investment management of funds. It required all Cypriot pension funds to file a statement of investment policy by the end of April. "This led to a rush of pension funds undertaking an asset allocation exercise in preparation for the policy," says Mannaris. "As a result, they have started to take a more objective-driven approach, set long-term targets, understand their risk budget and improve their strategic asset allocation. We witnessed an increase in diversification away from the local market to growth assets, mainly global equities and real estate. On the fixed income side, diversification from local corporate and government bonds, to euro-zone corporate investment grade and sovereign bonds is spurred by the small number of issuers - with only three to four banking institutions issuing corporate bonds in Cyprus - which can lead to liquidity, valuation and other problems."
Mannaris believes that average allocation to equities will remain relatively low at 10-20%. However, some - particularly, large defined benefit schemes - have been almost trebling their equity allocation from a current allocation of 10% to a strategic equity benchmark of around 30-40%. In real estate, Mannaris expects local, direct investments of between 10% of the total portfolio to a maximum of 40% for established property players.
The maximum 40% real estate limit is just one of many quantitative investment restrictions set by the new regulations. The main restriction is a limit on stocks and corporate bonds of 70% and a 15% limit on alternative investments, with more detailed restrictions on exposure to single issuers, self-investments and single plots of real estate.Pension funds are restricted to an investment limit of 10% of their assets on single currencies that are different from the liability currency. Under this regulation a Cypriot pension fund, for example, cannot invest more than 10% in US dollar-denominated bonds.
The vast majority of the approximate €750m invested assets of the Cyprus Telecommunications Authority Pension Scheme (CTAPS) are domestic government bonds and bank deposits topped with a small percentage of shares in Cypriot and Greek-listed companies.
In mid-2008, however, the pension fund adopted a new strategy, allowing investments in other asset classes such as global bonds, shares and property. However, by then the world was being drawn deep into the financial crisis. Therefore while they adopted the strategy the trustees decided to postpone its implementation until markets recovered. The only new investment the fund has started to implement so far is part of the domestic property allocation.
"Investors are still feeling very uneasy about the economic environment, which is why they are reluctant to move into new territory with unstable and volatile asset classes," says Maria Damalou, chief financial controller at CTAPS. "However, this is a challenge we have to deal with in the future because to remain entirely invested in bonds and bank deposits ultimately will not generate the returns we need in order to pay the pensions."
The €260m Hotel Employees Provident Fund (HEPF) undertook a new asset liability management (ALM) study in 2009. However, the new ALM model pointed to the same investment strategy that the fund had been applying before and which led to a total investment return of 6.55% in 2009, consisting of 15% equities, 15% bonds, 15% real estate, 15% loans to its members and 40% cash.
Nevertheless, the composition of the fund's equities portfolio changed. "We used to have 10% invested in global and 5% in local, namely Greek and Cypriot equities," says Marinos Gialeli, general manager of HEPF. "But we changed that to a tactical 15% exposure to global equities mainly due to the ongoing problems in Greece."
The fund's fixed income portfolio contains 5% global bonds, with the rest made up of local corporate bonds and to a smaller extent government bonds. Real estate exclusively consists of direct property in Cyprus. The new regulation though had no impact on the fund's asset allocation, says Gialeli, due to its already broad diversification.
With the introduction of regulation 1/2010 regarding the honesty, credentials and experience of trustees, the Cypriot Pension Regulator also formally set criteria for trustees. From now on, they are required to undergo professional training if they have no previous expertise and seek professional advice from consultants for their investment strategy.
"Until now this was optional resulting in trustees trying to guess the market and select individual securities," says Mannaris. "The new regulation has led to an increased demand for consultants and asset managers but in the end it is the funds themselves who will benefit the most from more professional management and a better governance structure."
The HEPF was already coaching its trustees prior to the new law, with consultants giving them lectures on investments and governance. "In 2009, together with the ALM study, we introduced an internal governance policy for the fund, which was published to all our members," says Gialeli. "This was a good step forward for the transparency of the fund."
For CTAPS, the most important task for the future is to divert from the safe path it has always followed and start implementing its new strategy.
The HEFP on the other hand is currently analysing other investment categories for the long term, which were not included in its new strategy, such as commodities and foreign exchange.