Portugal’s private pension system received a blow at the start of this year when the government removed the tax benefits on employee contributions to third pillar arrangements.
Ironically, the step was taken by a centre-right government that ideologically favoured private provision. However, it was forced to adopt stringent fiscal measures by Portugal’s budget deficit, proportionately the worst in the euro zone. A general election shortly afterwards saw a switch to the socialists, who had included the restoration of the tax incentives among their campaign promises. But since taking office in February prime minister José Sócrates has been unable to honour the pledge. Portugal is expecting a fiscal deficit this year in the region of 6% of GDP.
Historically, Portuguese governments have attempted to cover society’s pension needs through the state PAYG system.
“Occupational pension plans are relatively small compared with what the state has to pay from the state social security system,” says Hugo Rocha at Watson Wyatt in Lisbon. “Of the 200,000 or so companies registered in Portugal only 1,000 to 2,000 have an occupational plan. Because it’s not compulsory, because the economy is not very strong and because trading conditions are currently quite difficult pension plans are not high up the priority list for company finance directors. Pension funds in total account for less than 10% of GDP.”
But those funds in the market found results were good. “Since late-2002 almost every asset class has performed well,” says Vitor Sequeira, executive board member of Previsão, Portugal Telecom’s pension fund operator. Last year fixed income accounted for 40% of the portfolio, equities 30% and real estate 15%, with a further 5% each for commodities, alternative investments and cash.
Previsão restructured the pension fund’s management and implemented a new investment policy in 2003 and this diversification together with the good performance of almost all asset classes contributed to very good returns with a low level of volatility, Sequeira says.
“But we know that this can’t last forever,” he cautions. “Every now and then there are corrections. Also, we are living with very high oil prices and tight supplies and another challenge is the persistent low interest rate environment. The long-term interest rate is the best guidance we have for future expected long-term returns. This is particularly problematic for defined benefit pension plans.”
But Previsão is preparing for such eventualities. “Our current investment policy and asset allocation reflects these risks,” says Sequeira. “Our main focus is on investment discipline, diversification, finding uncorrelated sources of returns and reducing management costs. And during 2005 we further diversified our portfolio, increasing our exposure to commodities, inflation linked bonds, currency alpha funds and equity long-short strategies.”
Cimpor-Cimentos de Portugal, the pension fund for the building and construction sector, tackled the problem of how to guarantee that the profitability of the fund keeps pace with liabilities by dividing it, says Joao Salgado, head of the corporate centre at Cimpor-Cimentos de Portugal. “We have the defined benefit and the defined contribution schemes, and all new members since 1999 are placed in the DC division not the DB,” he says.
The portfolio breakdown has been almost unchanged for the past two or three years. “In 2004 it is 22.4% equities, 65.5% in bonds, 8.5% in hedge funds and real estate and so on, although this is mainly real estate, and 3.6% in cash,” says Salgado. “In 2004 we found that the performance of both equities and bonds was good.”
And while Salgado also sees potential problems on the horizon he is confident that his fund is robust enough to face them. “There are some challenges regarding the financial reporting standards in terms of the pension fund liabilities,” he says. “But we are fully funded, with liabilities of around €74-75m and a pension fund of around €74m.”
BPI Pensões, the pension fund manager of the BPI banking group, manages some 30 pension funds and negotiates an appropriate portfolio allocation with each, says Martim Guedes, head of pension fund investment at BPI Pensões. “The average age of the workers is the main difference between them so where the members are older we have about 10% equities and where they are young we can have 50%. The average is about 25% equities, which is also the average for Portugal. We have 7%-8% in real estate, 5% in hedge funds – the maximum allowed – and we have about 5% liquidity. And the rest is in bonds. We have used corporate bonds; two years ago we had 50% of our portfolio in corporate bonds but now it’s about 10% because the spreads are getting smaller. We switched mostly into government bonds, including inflation-linked bonds.
The backstop for the state system is the social security reserve fund, the FEFSS, which at end-June 2005 amounted to €5.93bn. It is managed by the Instituto de Gestão de Fundos (IGFCSS).
The fund is still only in its accumulation stage but while funding has been earmarked none of it was ring fenced.
“There were three sources of financing,” says IGFCSS board member Henrique Cruz. “The first was surpluses from the social security system, but there haven’t been any since 2003. The second is a legal obligation to transfer a portion of employee social security contributions, but the government is exempt from doing this when there are adverse macroeconomic conditions, and 2004 and 2005 have been difficult years. The third is from sales of social housing owned by the social security system, but currently this is a residual amount. So essentially we are reinvesting as last year only €30m was transferred into the fund.”
But a change in regulations last October widened FEFSS’ investment horizon from the euro zone to the OECD and saw an increase in equity allocation to 14% from 9%. “We reshaped the portfolio to enable us to meet our target of positive returns every three years with a return higher than the cost of the Portuguese portfolio,” says Cruz. As a result, during 2004 FEFSS’ investments posted a 5.9% time-weighted rate of return, he adds.
At the end of the second half of 2005 the FEFSS portfolio was composed of 50% Portuguese government bonds, 13% government bonds from other OECD countries, 8% OECD debt, 25% equities, up from the 14% in 2004 with most of the extra coming from OECD countries outside the euro zone. “We have a very indexed strategy so we are buying indexed vehicles to the benchmarks like the TOPIX, the S&P and the Belgian euro stocks,” says Cruz.
“In addition we had 2% in cash and 2% in real estate, of which 1.5% is in the Portuguese market. “Last year we started to invest outside Portugal and we want to grow that stake and are looking for other investment vehicles across Europe. We are targeting a real estate benchmark of 4% for 2005. We do 100% of our asset management in-house except for real estate where we select limited partnerships, REITS or other investment vehicles.”