FUNCEF and Banesprev are both moving to take advantage of Brazil's evolving pension
investment rules, writes Gail Moss

Fundacao dos Economiarios Federais (FUNCEF) is a closed pension fund for employees of Caixa Economica Federal, a Brazilian federal bank, managing three pension plans. The biggest, the Reg/Replan, is a defined benefit (DB) scheme. In 2006, 90% of its participants agreed to switch contributions to a new plan (the Novo Plano), keeping a proportional benefit in the Reg/Replan for the period they had contributed.

The other 10% of members stayed in the Reg/Replan. The scheme's liabilities amount to BRL125m (€51m), with 90% now inflation-linked, and 10% still linked to the sponsor's salaries policy.

The other two plans, the Reb and Novo Plano, have a DC profile during the contribution period and a DB profile in the retirement period, via inflation-linking.

Total liabilities for the Reb are BRL761m, of which BRL178m are for retired members. For the Novo Plano, total liabilities are BRL2.76bn, of which BRL125m relate to retired members.

With these two plans, the DC profile for contributions means that there cannot be a deficit during this period. But for all three plans, any deficit arising from DB liabilities would be split equally between sponsor and participants.

Contributions are also split roughly 50:50 between participants and sponsor.

For the Reg/Replan, these are BRL55m per year, with BRL1.4bn per year paid out. The Reb plan takes in BRL50m per year in contributions, paying out BRL$17m per year, while for the Novo Plano, BRL650m per year is paid in, and BRL10m per year paid out. The fund uses a discount rate for liabilities of 5.5% plus inflation as measured by the INPC consumer price index, and this is also used as a goal for asset-mix returns.

The fund's BRL44.2bn-worth of investments are entirely domestic, although it does have some international exposure via Brazilian stocks such as Vale, Petrobras and JBS which enjoy global revenues.

"Regulations took effect in September 2009, the middle of the financial crisis, making it more complex to invest abroad," says Demósthenes Marques, chief investment officer, FUNCEF. "We did decide to start investing abroad in 2010 but that year and the next were not good years to diversify because the macro-global scenario was very uncertain. But we hope to start investing when the scenario improves, although we don't expect Europe to solve its problems any time soon."

In the meantime, FUNCEF is taking advantage of this hiatus to increase its knowledge of overseas markets. "Fund managers who come to Brazil to invest like to meet us, because we know the local market," says Marques. "In return, we are learning from them about foreign stock markets such as New York and London. We keep studying these markets and contacting these managers so that we will get a valid overview of the global picture and when the time is right, start investing there."

The Brazilian capital markets have developed massively over the past 10 years, with the creation of the futures market and new credit products. The stock market BOVESPA now trades BRL5-6bn per day.

"FUNCEF has contributed to this growth as we have constantly been changing our portfolio in this period," says Marques.

The fund has recently carried out an ALM study, concentrating on liability-driven investing. The study was carried out to predict the future behaviour of asset classes to help the fund choose the best allocation, balanced between returns and risk migration.
As at the end of last October, 48.8% of the portfolio was in fixed income, 33.0% in equities, 7.3% in structured operations (mostly private equity), 6.9% in real estate and 4% in loans to participants.

The fund is diversifying its fixed income exposure. Over the past few years, it has changed a large amount of nominal short-term public bonds for long-term inflation-linked public bonds. At present, it holds around BRL16bn-worth of these - nearly 75% of its fixed income portfolio.

FUNCEF has built up its stake in private equity over the past six years. In order to balance risk, the portfolio is diversified over regions, managers' strategies and minority shareholders.

"At present, our investments are still in the J-curve, because they are so recent," says Marques. "But we want to increase the overall risk profile of the portfolio to a similar level as for European pension funds. We hope to get good results from private equity after 2013."

However, there are no plans to develop a hedge fund strategy until the fund has overseas holdings.

Marques says the loans to participants have given good yields over the past four years since they were started, averaging 9% plus inflation, with only 1% of defaults. "We didn't have them before, because the level of risk in the private market was very high," says Marques. "But now the risk level in that sector has stabilised."

Marques is not happy about the 8% limit imposed by law on real estate allocations, in which FUNCEF invests directly - Caixa Economica Federal is the biggest player in real estate markets in Brazil. "We could have more than that, as the real estate market in Brazil is well-developed," he says. "And our ALM studies recommend that we do not significantly increase our stock market portfolio."

The fund's total return for the 12 months to end-October was 4.91%, compared with its actuarial goal of 9.73%. The best performers were fixed income, which returned 11.89%, (compared with 9.67% for its benchmark Selic, the Brazilian Central Bank's overnight lending rate) and loans to participants, which returned 11.86%. Real estate returned 5.26% but equities made losses of 4.39%, although this was an improvement on the IBOVESPA benchmark of -15.82%.

The recent annual valuation of the real estate portfolio showed a 15% increase; including revenue, the annual return is over 20%, in line with last year's result.

"Returns this year have not been good but are better than in 2008," says Marques. "We didn't expect bad news from the stock market but in March last year it started to fall. The fall was less than it was in 2008, but this year almost all segments of the portfolio are falling below their targets."

However, from 2003 to end-October 2011, FUNCEF's accumulated return was 319.92% compared with an actuarial goal of 169.89% for the same period.

The Banesprev Social Security Fund was established in 1987 to supplement the retirement benefits and pensions paid by the Brazilian state. It is a closed private pension fund for employees of the former Banco do Estado de Sao Paulo (Banespa), formerly owned by the state of Sao Paulo and taken over by Banco Santander (Brasil) in November 2000.

The fund has 4,426 members and 22,958 pensioners. Its capital of BRL10bn (€4.2bn) makes it the eighth-biggest private pension fund in Brazil in terms of assets.

The fund receives around BRL3m per year in contributions from participants and its sponsor, but this has been decreasing since the pension fund closed to new entrants. The fund currently has BRL6bn-worth (€2.5bn) of retirement liabilities, 98% of which relate to DB arrangements.

Four-fifths of the portfolio is in fixed income, with the rest in equities, private equity, hedge funds, real estate and participants' loans.

Brazilian pension funds have the potential to play a large part in capital markets, as they represent approximately BRL300bn (€125bn) or around 15% of Brazilian GDP - and this has been recognised by the government. Previous regulations which shackled investment strategy have been partially relaxed to help that happen.

"Brazilian legislation affecting pension funds has recently undergone an evolution," says investment and financial manager Arlete Nese. "For example, in 2009, laws took effect which raised the limit for equity investments from 30% to 70% of pension fund portfolios. They also created specific limits of 10% each for private equity, hedge funds and real estate funds, and limited the total in structured investments to 20%. There is a limit of 10% for all foreign investments."

This opening up of investment opportunities is crucial for pension fund performance, says Nese, because it has allowed Banesprev to change its investment strategy, building up an allocation to alternatives via private equity stakes.

"Actuarial goals for the majority of Brazilian pension funds are inflation plus 6% , so we need to use alternative investments to maintain the respective rates of return," she says. "However, in order to achieve that, pension funds will have to go through a steep learning curve."