“Last year was pretty much the best year that Portuguese pension funds have had in five years,” says Bernie Thomas, senior consultant at Watson Wyatt in Lisbon.
“Returns were around 10%, which is very good for Portugal. There is still a lot of fixed-interest exposure. Typically, equity would take up less than 30%, real estate maybe another 10% to 12%, hedge funds a relatively small slice of 1% to 2% and the rest would be fixed interest rate.”
“Throughout 2005 our asset allocation was basically overweight in equities and underweight in bonds,” says José Veiga Sarmento of BPI Pensões, the pension fund manager of the BPI banking group and of 80 other companies. “And both of these factors were good contributors to our performance. Compared with a traditional mandate with a 25% equity benchmark, we held around 27% in equities, and in bonds we were on average 20% below the benchmark’s duration. Our equity fund selection was another positive contributor to our performance. Most of the funds we had in our portfolios outperformed their own benchmarks.”
BPI Pensões posted a 2005 return of 9.6%.
“The average pension fund portfolio had about 18% in Portuguese equities,” says Leonardo Mathias, head of business development at Schroders. “And the fact that a lot of pension funds still hold Portuguese equities was positive for them.”
Veiga Sarmento says: “The one part of our portfolio that did not perform so well was our position in US equities. We have US equities in most of the mandates we hold, even if the benchmark is only for European equities, and we do this for diversification as we feel that this strategy will outperform the benchmarks in the long run. But this didn’t happen last year because US markets lagged behind the European ones by a considerable amount.”
Pension funds play a limited role in providing retirement income in Portugal. The state PAYG pension is still being seen as the main provider of post-employment income.
“Although there are something like 200,000 companies registered in Portugal only 1,000-2,000 have an occupational plan,” notes Thomas. “It is not compulsory, trading conditions are relatively difficult and the economy is not strong so pension plans are not high up on the priority list for company finance directors. As a result, second-pillar schemes together have assets in the region of €15-16bn, or 10-12% of GDP. Of this, 50-60% belongs to the pension funds of banks which have their own pensions structure.
Most bank employees do not belong to the social security system and so their pension provision in effect provides a combined first and second pillar provision. So true second-pillar pension plans that act as top-ups to the state pension have assets that amount to about €5bn.
But Portugal’s demographic evolution and the government’s perilous budgetary situation mean that the state’s position is untenable. As a result the current left-of-centre government, like its right-of-centre predecessor, had embarked on a system of reforms. But like previous measures, the government’s proposals are less than adventurous.
“The proposals to alter social security would make it much more difficult to retire early and they are making the benefit structures much less generous,” says Thomas. “They are talking about putting a cap on certain benefits and are thinking of expanding the base on which contributions are made so as to bring in more revenue.”
“These are fundamentally parametric changes; it’s not a reform,” adds Mathias. “I think it is a welcome initiative to adjust the mortality rates and to adjust the retirement age of civil servants to that of the rest of the working population. But that’s it. What one would like to see would be that they incentivise the second and third pillar, and that’s nowhere to be seen. The fundamental issue is that they have to liberalise the system. The state cannot and should not be responsible for the retirement income of the whole population.”
The public authority pension reserve fund, the IGFCSS, is intended to help ease future pressures on the state budget. And last year it was able to diversify its investments. “We have changed the focus of our investment strategy,” says IGFCSS vice-president Henrique Cruz. “We experienced two simultaneous developments during 2005. The first was that we were allowed to invest outside the Euro-zone and the second was an increase in our allocation to equities and real estate. So that’s why we increased our absolute return in 2005 to 6.8%, primarily because the equity markets were performing very well. We are also looking at European real estate markets through funds.”
Because of its position as a reserve fund, the IGFCSS had previously been restricted to investing in Portuguese assets. “After 1999 this was enlarged to the Euro-zone and since late 2004 we have been allowed to invest outside the Euro-zone in other OECD countries, although only the advanced ones like those in Europe, the US, Japan and Australia,” says Cruz.
Following the relaxation of investment restrictions the IGFCSS undertook an asset allocation study. “It was not an asset liability management study because we are a reserve fund and liabilities are from the main state system and as projections involving PAYG systems can be very volatile so we decided just to allocate to the accumulating phase where we are receiving inflows,” he adds. “So we defined a maximum risk to the portfolio and then we constructed the optimum portfolio, the long-term portfolio that is our benchmark. We have made that for the Euro-zone environment and for the OECD environment and of course we see the possibility for greater returns.”
“Portuguese equities fell 4-4.5% in the second quarter but nevertheless over the first seven months it was quite positive,” says Mathias. “So those exposed to Portuguese equities performed relatively well.”
“The latest global tension is worrying and the higher oil prices and the rise in interest rates are not good news for equity markets,” says Thomas. “But having said that we haven’t seen any major changes in asset allocation. People seem to feel comfortable with their specific level of exposure to equities, be it 10% or 30%, and are saying ‘let’s keep that and see what happens in the medium term’. So from that perspective I don’t think we are seeing any pending selling pressure or drive to reorganise portfolios.”
“Looking forward we think that the opportunities for balanced mandates of pension funds lie in a dynamic asset allocation and an unrestricted fund selection,” says Veiga Sarmento.
“To be unrestricted means you have to be able to select the best managers regardless of which geographic area they get their alpha from. So this in turn means you will have to use portable alpha in the portfolios in order to get better returns. In bonds and equities we don’t have a long-term view since our asset allocation is very dynamic and short-term based. We think that alternative asset classes, mostly hedge funds and absolute return products, are becoming more interesting.”
“We do a tactical asset allocation so we have a reference that allows us to make some deviations from our benchmark,” says Cruz. “So we take tactical decisions according to our view for the short term. That’s the bottom line. Now, for example, we are overweight in equities and slightly underweight in bonds. But I see some risk on the equity side in the medium term. I think the market is moving too fast.”
The government’s reforms are expected to push back the date at which it will call on the reserve fund for support to fund pensions to 2036. “As soon as we are sure about that we are considering enlarging the fund’s real estate stake,” says Cruz.
Veiga Sarmento is moving in the opposite direction: “The only asset class we’re not so keen on going forward is real estate, even though we think that at least in the short run the REITs market will be driven by the considerable number of IPOs that will appear, especially in Europe.”