Portugal’s pensions landscape is subject to a two-tier domination by the main banks which provide their clients with a range of financial services, including pension management.
According to figures from APFIPP, the Portuguese Association of Investment Funds, Pension Funds and Asset Managers, the Pension Funds market consists of around E14.9bn. This relate to the APFIPP membership, which account for around 90% of total AUM. Around 75% of the figure is accounted for by the banks’ own pension funds, which also substitute for first pillar.
The domination of the banks also derives from the fragmentation of the Portuguese pensions market. “In Portugal a fund with assets of E50-70m is considered big,” says Martim Guedes, portfolio manager at Lisbon-based BPI Asset Management, the fund management arm of BPI Bank, the second-largest provider of pensions management services. “Apart from the largest companies like the state electricity company EDP and Portugal Telecom, companies do not have departments to manage their pension funds.”
According to a spokesman from APFIPP, “all funds are effectively a collection of assets – they have no legal personality. So the pension management companies correspond to the Anglo Saxon trustee model.”
A major constraint to the development of the second pillar is the generosity of the state system and the false sense of security it has generated among the population. It provides a replacement ratio of up to 80%, but this is decreasing: having been based on an average of the best 10 years’ earnings from the last 15; it now takes the form of an average career plan.
A fiscal incentive for second pillar schemes of up to 25% of the total employee contribution up to a maximum of E500 was scrapped at the end of 2004. Fiscal strain is a major issue in Portugal at present with the budget deficit at 6.2% - more than double the 3% limit required for membership of the euro.
However, there is another issue weighing on the government finances. “There isn’t enough to fund the state pension system,” Guedes explains. “So the government will reintroduce the fiscal stimulus to increase the savings rate. This will be a great boost for the industry. The stimulus will be introduced next year, according to a recent announcement from the finance minister.”
The new stimulus is less generous than the one it replaces with a tax allowance of 20% of the total employee contribution, up to a maximum of E400 per year for employees up to the age of 35, a maximum of E350 for those aged between 35 and 50 and up to E300 for those aged over 50.
João Pina Pereira, head of private and institutional clients at ESAF, the fund management unit of Banco Espirito Santo in Lisbon, is hopeful: “Second pillar pension assets under management could increase by 25% if there was a proper incentive.”
APFIPP has lobbied for the reintroduction of the fiscal stimulus. However, and association source was keen to temper enthusiasm about the possible reintroduction of the tax break. “The reintroduction of the benefit is important and needed but it must be complemented with other measures such as the education of savers,” an APFIPP spokesman notes.
In 2003 the development of the second pillar was dealt a savage blow when the government transferred the entire pension fund - some E1.3bn - of the Caixa Geral de Depositos (CGD), the post office savings bank, to the state coffers. The pension fund was converted to a state first pillar scheme. The government transferred a further E2.8bn last year. “The government did this to plug the state deficit,” says an APFIPP spokesman. But this is a very bad signal to send out.”
There are limits on investments for pension funds but most managers seem to be comfortable with them. Recently the limit on investments in equities was increased from 50% to 55%. There is also a limit of 5% on non-regulated investments such as hedge funds and private equity. However, there is flexibility if an ALM supports a higher allocation.
The 55% limit is hardly a constraint when viewed in the context of market trends. “The average fund has a little less than 30% in equities,” says Rui Guerra, investment consultant at Mercer’s Lisbon office. “The more aggressive funds may have 40%. The issue is more cultural, says Guerra.”
Meanwhile, the average allocation to hedge funds is 2-3%. “Investors/savers do not know much about these products and therefore they fear them and so tend not to invest in them,” the APFIPP spokesman says. “And also because of this, as a measure to protect the investors, the regulator keeps the investment limits of these products low.”
But clearly views on the subject vary by investor. Diversification is a key issue. “The current limit for hedge funds is 5%, but using capital guaranteed products we can increase our exposure for values around 10%,” says Pina Pereira.
“We’d love to have a higher limit for hedge funds. Our investment in hedge funds is always through a fund of funds due to the lower volatility. The crash of the stock market was a fantastic example of how fund of hedge funds can work because it helped us to meet the benchmark in that year.”
He adds that one of the big issues in the market is the quest for return in the current environment of low interest rates. “We are not expecting an increase in rates for the next couple of years. Real estate could be an alternative but right now it is not a cheap asset in Portugal. Real estate is not an easy market at the moment – yields have declined from 8-9% to 5-6%.”
In spite of the dominance of the market by the pension management companies, there is a move towards their use of foreign managers. A key issue is that almost all asset management is balanced with a significant proportion in bonds and cash. According to Mercer, more than 99% of assets are in balanced management. “But we are seeing the first signs of change,” says Guerra.
Pina Pereira goes further: “The biggest funds in Portugal already use both balanced and specialised mandates.” For example, for US equities they want specific foreign managers. There should be a an increase in the number of foreign managers used by a small number of big companies with very specific mandates.”
But he notes that the right of pension funds to use foreign managers as their pension fund managers may be three years away. “The Occupational Pensions Directive wants more freedom and the legislator is working on it,” he says.
Guedes believes that the directive will open up opportunities for foreign managers, but provides a sobering view of the real prospects. “Most of the market is already guaranteed for Portuguese players because 75% of the assets belong to the banks’ pension funds,” he says.
Hugo Figueiredo of the institutional asset management unit of BNP Paribas in Lisbon notes: “It is difficult to get inside local companies because pension funds are conservative. But they are opening up to foreign managers; we have established a relationship with the pension fund of one of the major banks. But open architecture is still in its infancy here.”
A good example of outsourcing can be found at BPI. Guedes explains: “We are setting up a system in-house to select the best managers, and we see the benefit of this particularly in equities management where there is the greatest divergence between the good and the bad managers. We will buy investment funds from foreign managers in niche asset classes such as emerging market debt, high yield, and US equities. We will also outsource European equities where find a good manager.”
But with the big local financial institutions dominating pension management and, understandably, pushing their own products ahead of those of their foreign rivals, the independence that one looks for in a multi-manager may be compromised through a clear conflict of interest.
When it comes to looking abroad for more specialised management the sophistication of the pension fund itself is clearly of key importance. There was good news on this front in 2003 when the government introduced a ruling requiring pension funds to have a formal investment policy.
The objective was to bring the liabilities side of the equation to the fore of investment thinking on the part of both managers and pension funds.
This has had a significant impact on the Portuguese market. “The supervisory entity clarified the management of the pension funds and gave the companies an active role in the management of their pension schemes,” says Marta Magalhães at CGD’s fund management unit. “With it managers found a much more efficient support for their work.”
Guedes goes further: “Asset management is more disciplined and more transparent. “It has made companies more aware of the age distribution of their workforce and we are now seeing different portfolios with different age profiles. There is more understanding of risk. There are more consultants because all companies have to produce an investment policy.”
But he notes: “BPI does actuarial studies so in that way we act as a replacement for the consultant which one can argue is not impartial.”
The impact on asset managers may be significant. “Funds are now looking at outperforming the benchmark,” says Guerra. “If the manager is not outperforming the pension fund will look to change the manager. Pension funds have tended to look to their own bank to do the asset management but increasingly they are considering other managers.”
Progress looks promising but a market that is still too rigid and an economy that is at best lacklustre mean that Portugal’s pensions market will lag behind the European mainstream for the foreseeable future.