Nina Röhrbein spoke with Marinos Gialeli, general manager of the Cyprus Hotel Employees Provident Fund, about its approach to managing its clients’ assets in a period of global economic downturn

If, when you think of Cyprus, pictures of beaches and olive trees spring to mind, think further. Closely allied to the tourist industry, the Nicosia-based Hotel Employees Provident Fund (HEPF) is a defined contribution scheme for all workers employed by the country’s hotel sector. It was founded in April 1968 and now has assets of around €260m.

The fund has scooped IPE awards for Best Pension Fund in Small Countries two years in a row, as well as the Best Small European Pension Fund Award in 2010.

Membership is mandatory for the employees of hotels that have signed agreements with the relevant trade unions. They become members of HEPF six months after they start working. Contribution rates stand at 20% per annum and are split equally between employers and members. At present, the fund boasts about 13,400 members, of which 8,500 are active. The rest are deferred members who have decided to keep their money in the fund. This is not the norm however.

In Cyprus, when employees change their sector of employment, they take their pension with them. The fund neither retains the money until the employee retires nor does it transfer it - it has to pay the accumulated capital out whenever an employee decides to leave their employment.

At present, HEPF only has one investment strategy for its members. “However, we are in discussions with our consultants to develop more investment strategies to try to give our members a choice in which investment line they would like to participate,” says Marinos Gialeli, general manager at HEPF. “It is something we will be working on in 2011 so it becomes available to members in 2012.”

In 2009, HEPF undertook its second asset liability management (ALM) study. In line with the study, it is currently invested to 28% in bonds, 15% in equity, 10% in real estate, 17% in loans to its members and about 30% in cash to try to reach its annual return target of 5.1%. Equities and global bonds are active portfolios, with a 100% currency hedge for bonds, while the rest of the asset allocation is passive.

“Cyprus generated a good yield of 4.5% in fixed bank deposits in 2010, which encouraged us to keep this large amount of money in cash,” says Gialeli. “As we now expect a rise in interest rates we do not plan to reduce our cash amount at this moment in time either.”

As the fund does not own any local equities, all of its equities are invested in unconstrained global mandates. Even during the financial crisis, HEPF stuck by its 15% equity exposure. “As a long-term investor, we are not in business to alter our decisions very quickly every time the markets change,” says Gialeli.

In fact, although the financial crisis led to a drop in members from 14,000 to 13,400 and an increase in outflows, it hardly altered its asset allocation. This was largely due to the unchanged fundamentals of HEPF members. “The average member age remained the same, their retirement age stayed the same and the power of Cypriot banks remained the same - this is why we kept our investment approach,” says Gialeli. “The ALM study of 2009 re-confirmed the strategy. The only aspect we changed - which was a big move for us at the time - was the composition of our equity allocation. We used to have 5% of our total equity allocation invested in local, namely Greek and Cypriot markets. But after we realised there were problems with the Greek economy we changed our equity allocation over a three-month period to a 100% global exposure in early 2010. This saved us a lot of money.”

In contrast to its equity portfolio, HEPF’s real estate portfolio is entirely invested in local properties and there are no plans to invest in global real estate investment trusts (REITs) for the foreseeable future, for example.

All the properties are located in the capital, Nicosia. These include shops and offices, but are mainly, buildings let to the government, which, Gialeli says, on average produce a yield of around 3.2% from rental income and another 3% from revaluations.

HEPF also gives loans to its members for educational, health or housing purposes. They can borrow up to 75% of their salary.

At present around 2,500 members are borrowing HEPF’s money. The pension fund board decides whether to accept loan agreements every six months and also agrees the interest rate to be charged, which has been set at 4% over the last few years.

Of the 28% allocation to bonds, 6% is currently invested globally. The rest is made up of local corporate bonds and, to a smaller extent, government bonds. However, with most of the local bonds due to expire in 2011 or 2012, the capital available has been earmarked towards global bonds.

“While we are not invested in Greek bonds, Cyprus bonds have a high correlation to them,” says Gialeli. “Therefore, the problems of the Greek economy have also had an impact on our bond exposure. Local bonds are terrible - in fact there is no market - which is why we are eventually disinvesting on maturity. We aim to go global with the remainder of our bond allocation as soon as it is possible, and expect to be fully global within five years.”

The fund’s bond benchmark is the Barclays Global index, while its equities benchmark is the MSCI World index.

With the introduction of regulation 1/2010 regarding the honesty, credentials and experience of trustees, the Cypriot Pension Regulator formally set criteria for trustees, requiring them to undergo professional training if they have no previous expertise and seek professional advice from consultants for their investment strategy. But HEPF was already coaching its trustees prior to the law, with consultants giving them lectures on investments and governance.

Due to its already broad diversification, regulation 2/2010, which came into force in January 2010, had no impact on the fund’s asset allocation.

The main restriction the regulation introduced was a limit on stocks and corporate bonds of 70% and a 15% limit on alternative investments. Cypriot pension funds are also restricted to an investment limit of 10% of their assets on single currencies that are different from their liability currency or single investment.

Apart from the move into global fixed income, other asset classes are also a discussion point for HEPF’s 13-strong board, which consists of six trade union and seven employer representatives. The president is always appointed on the employer side, while two of the trustees are the secretary-generals of each of the two trade unions, with the other four trade union representatives elected annually.

“We have discussed different asset classes such as hedge funds, commodities and foreign exchange with our board members and trustees,” says Gialeli. “Our trustees have already attended a training seminar on different asset categories, which we plan on doing again. With our next ALM study, which is due in 2012, we are likely to add some new asset classes, most probably hedge funds.”

In terms of risk management, HEPF’s strategy is plain and simple: diversification. Risk management focuses on modelling failure against a total replacement objective per member. It has a value at risk (VaR) level of 5% annually, which is tested every six months with the help of its consultants.

Annual inflows to HEPF make up around €20m. However, this cannot disguise a more fundamental problem the hotel industry has to deal with: “For every two young employees that join the pension fund, 50% will stay on until retirement but the other 50% will leave the sector altogether, according to our own analysis,” says Gialeli. “This is a big problem for a €260m fund, which would be much bigger if it were not for us having to pay out the contributions to every leaving member, although, at this moment in time, inflows and outflows are evening themselves out. I have talked to the government and trade unions about this problem and tried to raise awareness about it in the local media. The trade unions still believe that it is the employees’ money and that ultimately it is the government that should pay for their pensions. What they fail to realise is that eventually this will not be possible anymore.”