Like many other Polish financial reforms, the private pensions system was designed to boost the local capital markets. OFEs operate under a range of investment caps – except in the case of state treasuries where investment is unlimited – including a 40% limit on publicly traded Polish equities, 10% in the security of one company, and a 5% limit on overseas investment, which is restricted to OECD countries.
The OFEs accumulated nearly PLN19.5bn (e5.4bn) of assets by the end of 2001. Cezary Mech, president of UNFE, the regulator, forecasts that their assets will have grown to around $125bn (e140bn) in 20 years’ and $500bn in 50 years’ time, equivalent to some 50% of GDP. The largest proportion of fund portfolios remain invested in state treasury bills and bonds, an average 68% as of end-2001, relieving the government of having to rely on overseas investors to fund the budget deficit.
The funds had a total PLN5.254bn invested in equities as of the end of 2001, an increase of 48% since the end of September 2001, while the equity share of total portfolios grew from 24% to 27.9%. With PLN600m–800m of new money to invest a month, most funds will have to keep buying stocks if only to maintain their current asset allocation. Wieslaw Rozlucki, CEO of the Warsaw Stock Exchange (WSE), estimates OFEs account for around 5% of the exchange’s market capitalisation and 15–20% of the free float.
By equity investment size the two largest players are Commercial Union and ING NatNed, which between them had PLN1.986bn invested as of the end of September 2001. By percentage the DOM fund had the highest allocation, 33.5%, followed by Pocztylion at 28.1%. Despite the variations, the issue of benchmarking, where those funds whose two-year internal rate of return falls below half the weighted average in any quarter are fined, is obviously exerting an influence on investment decisions.
Some funds, for instance that run by Kredyt Bank, kept its equity exposure at a relatively low 14% because of key fundamentals such as a deteriorating economic performance, ballooning budget deficit, unemployment close to 17% as of early 2002 and high interest rates. For the year as a whole the WSE’s performance was poor, with the broad WIG index down by 22% in zloty terms in 2001. Unfortunately Kredyt missed out on the October rally caused by the relatively smooth formation of a government after the 23 September election, and saw its rate of return fall to 16.4% in the last quarter of 2001 from 18.5% three months earlier. In the coming year it likewise intends to keep its stock purchases modest. “Our outlook on the Polish stock market remains negative,” says Jerzy Lennard, vice president at Kredyt Bank. “The looming recession in Poland will adversely affect stock prices; likewise Poland, as part of the global economy now, will be affected by economic events in western Europe and the US.”
Pension societies with large equity exposures, such as ING Nationale Nederlanden, which had 32% of its portfolio in listed Polish equities in 2001 and intends to maintain a similar allocation this year, argue that regardless of their quality, Polish stocks are undervalued and set to benefit from European Union convergence play, much as Spanish and Portuguese equities did during the run-up to those countries’ accessions.
Although by regional standards the WSE is a big exchange, with 231 listed companies and a market capitalisation of PLN111bn at of the beginning of 2002, large chunks of major stocks are held by strategic investors, and the free float is estimated at only 30% of the total capitalisation. Supply remains a problem. In 2001 eight new companies were listed, but four delisted, a trend which is set to continue in 2002 as further companies, including the construction giant Exbud, set to leave because the WSE’s onerous reporting requirements coupled with the better fund raising opportunities on larger overseas markets. With the possible exception of an IPO for insurer PZU, the coming year is not expecting any significant privatisation issues.
Market participants complain constantly about liquidity, and in addition the thin market is volatile. Many were taken by surprise at the WSE rally at the beginning of this year, with the WIG20 index rising 12% in the first four trading sessions. “It makes us uneasy,” admits Dariusz Adamiuk, deputy CEO and chief investment officer at PZU PTE. “One of the reasons why we want to invest overseas is that we don’t want to create a speculative bubble in the local market. It’s shallow and there are very few companies worth investing in.”
In addition to their obvious effect on prices, the funds are increasingly exercising their shareholder role in corporate governance. Last year pension funds, along with other institutional investors, took legal action against Michelin, the strategic owner of listed tyre manufacturer Stomil Olsztyn, and attempted to block a merger between Bank Slaski and its strategic investor ING Bank. This is a controversial issue for the regulator, which believes their role should be purely passive, while the pension companies argue they have little choice. “In theory pension funds should be passive investors, and if we don’t like a company we get out,” says PZU’s Adamiuk. “In practice, because of the liquidity problems, we’re stuck, so we have to improve the value of the stock through corporate governance.” The funds’ actions nevertheless have the full support the WSE, which has set up a Corporate Governance Forum working on issues such as a code of best practice. Says Rozlucski: “They should be demanding better returns and shareholder value.”

The funds’ ability to exercise corporate governance would increase further if the current limit of 10% on any one company’s equity was expanded. “The 10% limit sounds like a lot, but a fund of our size is already experiencing problems,” complains Michal Szczurek, CEO of ING Nationale-Nederlanden pension society. Another unpopular limit, the so-called Article 142 rule, obliges funds to keep 95% of their portfolio in publicly traded securities. This limits the funds’ ability to diversify much into albeit riskier real estate, private equity and venture capital funds, but has intensified calls for the ability to offer younger clients separate funds with higher risk profiles.
With the local capital markets unlikely to expand in the near future at the same pace as asset inflows, the funds want to see the current 5% limit on overseas investment expanded. Under the current regime only the largest funds by asset value find it cost-effective to take advantage of overseas opportunities, and so far only Commercial Union, ING Nationale-Nederlanden and PZU have done so. ING Nationale-Nederlanden, which in 2000 was the first fund to buy foreign stock, has around 1% of its portfolio invested, mainly in European equities. Szczurek describes the procedure as bureaucratic, and the 5% limit insufficient to maintain diversification.
Politically the issue is highly sensitive. “Is pensions reform designed to secure local capital markets or future pensions provisions,” asks Iain Batty of CMS Cameron McKenna. The arguments against raising the limits focus on prioritising domestic investment in a developing economy. “Poland is currently a capital importer. We need to attract investment to reduce unemployment, and raise wages and production,” argues Mech. “In addition, future first pillar payments are tied to wages growth, so from the pension fund members’ perspective it is more beneficial to invest domestically. A 1% increase in investment return as a result of Polish country risk premium will result in a 20% increase in future pensions benefits.” The issue has found its way into Poland’s accession talks with the EU, with some negotiators arguing that it breaches the EU’s treaty on free flow of capital, while Poles have pointed out that the second-pillar schemes, privately run though they are, are still part of the social security system.