This year has seen a slowdown in the creation of new pension funds in Portugal. The awaited reform of the social security system, the real key to the future development of the industry, has not yet materialised, and although the debate is still alive, so far no major steps have been taken.
The government has once again announced its intention to reduce the retirement benefits of the system to a full career average, instead of the current almost final salary pension, and the unions have once again opposed this initiative.
The social security has been without doubt one of the main focuses this year, especially since the announcement that it will outsource part of its reserve fund to external managers. The decision has been welcomed within the industry, which sees this development as a significant step forward.
As is happening in Ireland, where the government has recently taken a similar initiative, the outsourcing of part of the public system fund assets has attracted the attention of domestic and foreign players wanting to get a piece of the cake during the tender process. To date, not much is known about who, and in what proportion, will be managing the assets.
Whatever the final decision is, it will be a very political one. If the fund is to select only domestic players it will be criticised for lack of diversification. If it opts for more foreign managers, there will be disappointments among the local houses.
The fund that was created more than a decade ago to plug future holes in the country’s social security system, will outsource 20% of its e3bn total assets. Early this autumn, Pedro Barroso, head of investments for the fund, commented that the mandates could be awarded by the end of the year and will probably be related to the European equity and fixed income arena.
However, the very conservative portfolio of the fund with investment restrictions of a minimum investment of 50% in Portuguese public debt, a maximum of 20% in equity, will bring important limitations to future investment strategies, although Barroso is optimistic that these limits could be relaxed.
As mentioned earlier, foreign firms have shown more interest in the Portuguese market since this announcement, but their presence in the country was already strong before this development. Just thinking about the most recent mergers and acquisitions within the banking and investment industry, we see that foreigners have found a place in the local market. A good example is pension fund manager Pensõesgere, top of the list in terms of market share with, according to data from the Istituto de Seguros de Portugal (ISP), around 24% of total assets. Created in 1999 after the merger between fund managers Praemium and Vanguarda, Pensõesgere merged with Mello Activo Financeiros last year after the acquisition of Banco Mello by Banco Comercial Portugues (BCP). To complicate things further, London-based Foreign & Colonial now owns a significant proportion of the company and, because of this, most of the asset management activities of Pensõesgere are now being done from the UK.
Another example of foreign presence in the market is Santander Pensões, before MC Pensoes, the pension fund managers linked to Banco Totta & Açores acquired by Spanish firm Banco Santander in 2000. Santander Pensoes is today among the top 10 pension managers.
“Portugal has always been a very open country and foreigners have always had an important presence through all the industry sectors,” says Jose Mendinhos, general manager of asset management company Futuro in Lisbon. “In many other countries the preferred products are always those that have been manufactured internally but it is not the case here. Portuguese people want good products, no matter where they come from.”
At William M Mercer in Lisbon, investment consultant Rui Guerra agrees: “Many foreign houses are present in the market in one or another form. Some Portuguese managers use unit trusts run by foreign houses to get exposure to specific regions or sectors and, also, some of them have strong links to international houses for the outsourcing of part of their assets.” He adds: “This is a trend that is going to continue.”
On the same lines, and when it comes to investments, the international orientation of Portuguese institutional portfolios is a fact. According to data from William M Mercer , the exposure to Portuguese equities in pension funds portfolios only represented 5.4% of total assets at the end of June; six months earlier it amounted to 8.7%.
“Pension funds have been looking more and more outside the Portuguese market,” says Guerra. “The Portuguese market is too small and too volatile.”
With only three or four strong stocks in the market – one of them being the Portuguese telecom company which has almost half of its assets invested in the highly volatile Brazilian market – the need to go outside is clear. The percentage of assets invested in Euroland by pension funds in June was 18.7% of total assets, with the exposure to US stocks only representing 2.4%.
On the fixed income side, and also according to Mercer, the proportion of assets invested this way represent 60% of total investments, with around 38% invested in Euro-zone.
The bad returns of the equity markets are worrying Portuguese investors, who had increased their exposure to this asset class only in the recent past. “Last year was a warning and we have median returns of 1.2% – low but not negative as we are going to see this year,” says Guerra. “What we are advising our clients to do in order to cope with this situation is to monitor the results closely and not ot set specific benchmarks for their pension funds which reflect the specific level of risk they can take.”
Significant moves away from equities as a result of the down markets are not expected. “We tell our clients that indicators like volatility and prices would suggest buying,” Futuro’s Mendinhos says. “But you have to have stomach to do that. We are not optimistic about the short term and at this moment we have a defensive strategy, waiting for the markets to recover.”
At consultancy firm Watson Wyatt in Lisbon, senior consultant Carlos Ravara says: “During the first months of this year, when the markets started performing really badly, we received a lot of calls from our clients waiting to change managers, but we told them that wasn’t the solution. If you compare the performance among manager they are all in the same situation, so swapping from one to another won’t solve any problems.”
He adds: “Our advice to pension fund is always to focus on the long term and do asset-liability studies to see if the asset allocation they have is the one they need, and the message is getting across. However it is necessary to say that many pension funds are so small – the average size is below e5m – that they cannot afford this type of study, or indeed truly assess their added value. We hope regulators also focus in the long term to help these funds to concentrate on the right investment structures.”
Ravara also highlights the increasing discussions among managers about including alternative asset classes in their portfolios. “Hedge funds are becoming more popular within the investment community and some managers already see them as another asset class to be considered in their portfolios. Some pension fund managees have allocated 10% of total assets to these investments, and most Portuguese players would use fund of funds or joint ventures with international houses to get exposure to this asset class.”
At the recently established Schroders office in Lisbon, managing director Leonardo Mathias agrees: “Managers are closely looking at hedge funds as an alternative to increase portfolio diversification. Since we have our own family of hedge funds this is an area where we see possibilities for us.
“In general we believe that the market will eventually evolve towards more equities, more specialised products and more outsourcing, and this is where we are positioning ourselves.”
Mathias explains the possibilities within the Portuguese market, where “there is a lot of work to be done”. “This is a very young market that is in the process of opening to foreign third-party providers. There are three interesting sectors to get involved in and this is what we are working on at present,” he says. The three sectors are: first, the foundations and charities arena, a sophisticated group that has been using third-party providers for some time; second, the pension funds, with more limited opportunities due to investment restrictions, and third the wholesale market, this is white labelling and fund of funds. “These three sectors are at different stages of development. Pension funds still have a huge percentage of assets invested in bonds, but we see that 6% of their portfolios are being invested through mutual funds. So there are opportunities for more third-party arrangements.”
More opportunities for locals and foreigners will come sooner or later, and the key now is to be patient and get prepared for the future market needs. In this area, Victoria, part of insurer group ERGO, is now setting up a specialised pension fund management subsidiary, as a joint venture with another financial institution. “Although we haven’t seen many developments in the industry for the last year or so, we still believe the future of retirement systems in Portugal will be more funded pension funds,” says Francisco Campilho, financial manager at Victoria in Lisbon. “After all, the concentration process that took place within the market the choice of providers is much narrower now than it was three years ago and that’s one of the reason why we are creating this pension fund management company.” He adds: “Although we do manage pension fund assets within our life insurance company, we want to create something which is only focused on pension in order to be ready for the developments of the market, that will come eventually. We want to give our pension fund business its own structure and find a place in the market now.”
Although a good strategy for the long term, for those thinking of following similar paths, the near future will most certainly be disappointing. The next few months are expected to be quiet. Worse returns than last year’s will make investors even more nervous, and maybe lead them to adopt more defensive investment strategies. And, and this is the more important factor holding back market growth, serious reforms in the social security are not expected to happen soon.

Topics