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Impact Investing

IPE special report May 2018

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Crisis management

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As CEE asset managers lick their wounds, regulatory regimes have come into focus again. In Poland's highly regulated mandatory pensions system the funds had, as of October 2008, suffered a 16% loss on the year to date, their worst performance since the start of the system. However, the difference between the best and worst years was only 4.5 percentage points, a factor stemming from the requirement that the funds provide a minimum guaranteed rate of half the weighted average of all fund performances.

Ewa Radkowska, (pictured right) head of the investment department at ING PTE in Warsaw, believes that the minimum guarantee has exacerbated losses: "We have pointed out that the minimum guaranteed rate of return is not a good safety net for the industry. It forces us to constantly look at each other and makes our asset allocation and the duration of our fixed income portfolios similar."

Polish pension funds also had little scope for mitigating losses. While the Warsaw Stock Exchange now ranks as Europe's fourth-largest exchange for stock index futures, pension funds cannot use these or other derivatives, for hedging or other purposes.

"This makes changing portfolios more difficult; we have to sell assets because we cannot hedge them," adds Radkowska. The 5% limit on overseas investment, while maintaining a large institutional investor pool for the domestic stock market, has also contributed to some of the recent extreme fluctuations. As Radkowska notes: "The pension funds are too large for the Polish market, hence the danger of first inflating and then deflating it. If we could invest abroad, the changes would have been less abrupt."

Conversely, the outcome could have been even worse. "There is the counter argument that without this limit some pension funds would have probably invested in Lehman Brothers bonds or similar," notes Michal Szymanski, CEO and CIO of Commercial Union Pension Fund. "The current situation showed that there should be investment limits for certain risk factors, while the level of pension fund manager skills is currently not that high for a no-limit environment."

The early responses of the regulators to the financial crisis focused on crisis management. The region's institutional investors play a key role in helping finance budget deficits by buying government securities, and a number of countries faced a liquidity squeeze that threatened to freeze Treasury bond issuance. In Poland the Treasury market ground to a halt in October until the government and central bank raised deposit guarantees and eased bank liquidity, including providing a foreign exchange swaps line, which in turn enabled institutional investors to sell treasuries and find counterparties.

In Hungary the introduction of life-cycle pension funds proved problematic. According to the National Bank of Hungary, pension funds decreased their purchases of government bonds in 2008 as part of the shift to multiple funds, although by mid-year they, together with insurance funds, still accounted for 25% of Hungarian government bonds.

In response, in October the government lifted the 40% floor on equity investment for the most aggressive life-cycle portfolios in order to free up more resources for government bond investment, a move that has met with a mixed response from the pensions industry. "It would not be in our members' long-term interest to sell equities in order to buy back government bonds," says Gabor Borza, managing director of ING mandatory and voluntary pension funds.

However, government bond portfolios also suffered heavy losses as yields rose, especially when the central bank hiked interest rates to shore up a weakening forint and the government approached the IMF for a rescue package.

In Croatia, following an October year-to-date plunge in investment fund net asset value of 63% to €1.6bn, the authorities established a stability fund, sponsored by Croatia's four mandatory pension funds and four largest investment funds, allowing small mutual funds seeking closure to obtain capital to repay shareholders.

For the mandatory pension funds, where returns were down by 15% for the year as of November 2008, there were concerns that the financial crisis could lead to stricter investment limits for pension funds or greater use of their comparatively high liquidity. "There is a tendency to think that pension fund liquidity should be used to ease budget deficits," says Dinko Novoselec, (pictured left) CEO of AZ Mandatory Pension Fund.

In the wake of Argentina's decision to nationalise the private pension system, "we are afraid that the crisis will jeopardise the very existence of pension funds", Novoselec says.

Latvia has already frozen the employee contribution rate at the 2008 level of 8%. It was set to rise to 9% in 2009 and 10% the year after.

"As the economy slows there are discussions to lower the contribution rate," adds Roberts Idelsons, president and CEO at Parex Asset management.

In Lithuania, where the newly elected centre-right government's priority is to slash the 2009 budget deficit, including that of the social security fund, contribution reductions are higher up the agenda (see page 38).

Other countries are either biding their time or have taken a more relaxed view. In Estonia, the equity limit for growth pension fund portfolios was raised to 75% in the summer of 2008, and investment in real estate, private equity and other alternative assets eased.

Fabio Filipozzi, CEO of Swedbank Investment Funds, praises the authorities for acknowledging that pension fund investors with 30-40 years to retirement should be allowed to take a higher investment risk. And he praises the raising of potential real estate allocation. "Real estate is one way to lock in a liquidity premium over a 30-year horizon," Filipozzi says.

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