Pension and investment funds have led the way in increasing international diversification says Avelino Hernández of BanSabadell Pensiones
The management of investment and pension funds in Spain has experienced a significant transformation in recent years. The perspective of the EMU and the modifications occurring in the economic scene have brought about this change. In the future, we expect this transformation will speed up, which will mean new challenges for all managers in our country.
For Spain, the path towards the monetary union has not been easy bearing in mind the significant macroeconomic imbalances it has suffered from continuously in the past. In spite of this, Spain has successfully overcome this challenge and has been able to keep inflation and public deficit levels down to 2% and 3% of the GDP respectively.
From a savings' point of view, the success of the battle against inflation has had a very positive impact on the development of institutional investment. The decrease in interest rates and tax changes have favoured a growing movement from savings and de-posit accounts to investment funds, which mainly invest in bonds and equities. Just in the last 12 months, investment funds have increased their volume by Pta9.3trn to reach a total of Pta22.2trn (28% of the Spanish GDP in 1997). Favourable tax treatment, progressive demographic ageing and cuts in the 'Welfare State' have also encouraged a strong increase in pension funds (43% from March 1997 to March 1998) to form a volume of approximately Pta3.6trn.
In this context, institutional management has been directed towards the progressive development of mixed (combining fixed income and equities) and purely equity funds. They have practically doubled their significance on the total volume of investment funds over the last year, from a low 14% to 27%. Another important trend in the management of Spanish investment funds has been a greater internationalisation of investments, from 2% of the total a year ago, up to 7%. The perspective of the euro and the resulting disappearance of exchange risks, has been a decisive factor in the growing trend of internationalisation of Spanish fund management. The certainty that the single currency will lead to extending our domestic market to 11 founder countries of the euro, has speeded up entry into the stockmarkets of these countries. By adopting an approach depending more on sectors (instead of the traditional approach on countries), fund managers have started to take advantage of operating in a wider and more transparent market. The diversification of risks has been an important consideration when taking up positions abroad, particularly in view of the peculiar composition of sectors of the Spanish stockmarket. For example, banks and electricity companies enjoy weighting of almost two thirds of the Ibex-35 index, while there is very little representation from such important industries as technology, pharmaceuticals or business equipment.
The management of pension funds is also progressively directed towards equities and international assets. From a percentage of 6.7% of total volume at the end of 1996, equity weightings have increased to 14.5% at the end of the first quarter of 1998. Similarly, international assets have increased from 3.8% to 11.8% of the total over the same period. Fixed income has suffered most from this change with a drop from 64% to 54% of the total investment of pension funds.
The growing importance of equities over traditional fixed income is a factor which, in our opinion, will set the pattern for funds in euros. The loss of importance of fixed income assets will firstly be due to the relative shortage of public securities due to the reduction of budgetary deficits. Secondly, the downward stability of inflation, which the single monetary policy intends to guarantee, will lead to modest return expectations for bonds in general.
The investment in equities will also be favoured by an increasing financial culture among private European investors. The emergence of a wider and more efficient market, together with the relative stability in interest rates, will contribute to the development of this culture. Under these circumstances, liquidity could continue entering the stock market, which will become a basic instrument to finance and expand European business.
From the point of view of our management, the need to adapt to the new European stock scene, obliges us to propose a change in our benchmarks for equities. In this way, the Ibex-35 index of the Spanish stock exchange is replaced by another index with a similar number of companies and which is fully 'euro' and with a similar methodology as the Ibex.
Apart from the 'euro' area, we also believe that investment in equities should also consider the relative importance of the US, British and Japanese markets. In stockmarket terms, they represent a very substantial part of global capitalisation. However, our view with respect to these markets, is not particularly positive owing to different reasons. In the case of the US, the high levels in stock valuation after a long period of upswings, contrast with an expectancy of progressive drops in growth levels of company profits. In Great Britain, the risks of inflation and the over-valuation of the pound, continue to reduce potential with respect to other markets. Finally, Japan and the majority of emerging zones in Asia, face in the near future, a situation of low economic growth and the need to undertake considerable restructuring processes, particularly in the financial sector.
Unlike English-speaking countries or Japan, the size of the equity markets in Europe and Spain is still low. Although the privatisation processes of wide spaces of the public sector in recent years have partially lessened this, it is expected that the development of equities will be parallel to the good yield prospects expected over the next few years. In fact, the current cyclic recovery in Europe favours corporate results and therefore, their quotation on the stock market. Also, corporate consolidation and restructuring in view of the single market, should help to increase effectiveness and profitability.
Within the stockmarket which is going to take shape in the future monetary union, we believe that Spanish companies with a significant presence in Latin America, will be a good complement to portfolios of European managers. These include the BBV and Santander banks and the operator Telefónica. The most recent results of all of these have demonstrated the good growth of their business figures in this region and their potential to compensate for a much more competitive environment in their local market. By sectors, we believe that banks (and stocks of the financial sector in general), will continue to benefit from the restructuring and consolidation which Europe is undergoing. Similarly, the sectors most sensitive to an increasingly consolidated economic cycle, namely building, business equipment and consumer goods, etc, offer the best prospects at the present time. Our management also values very positively the medium-term potential of companies such as Endesa and Repsol. Endesa has recently concluded its privatisation process and also bases its long and medium-term expectations on its expansion into Latin America. Repsol stands out for its defensive behaviour within the European petroleum industry, as a result of its lesser degree of sensitivity to the changes in the price of oil.
The greater involvement in equities and also in corporates (as the lower needs of public financing reduces the offers of public debt), will be one of the greatest challenges facing fund managers over the next few years. We believe that this change in the investment pattern will be 'structural', with the same implications as in the single currency process. Therefore, this challenge should have a well defined strategic vision and should contemplate very carefully the more microeconomic factors of the market.
Avelino Hernández is investment policy director at BanSabadell Pensiones in Sabadell