Four years of strong economic growth and satisfaction with the government’s effort to take Portugal into the single currency have given Socialist prime minister António Guterres another victory in a general election.
The next four years will be more challenging for the prime minister, with economic growth less satisfactory than during his previous term of office. Portugal’s position within Europe will be reinforced in January when the country assumes the rotating presidency of the EU.
The introduction of the euro has had a big impact in the Portuguese market. “The euro has changed significantly the approach that managers are taking in terms of investment strategies,” says Rui Guerra at consultants William M Mercer in Lisbon. Without taking on currency risks, managers are now able to consider the whole of Euroland as a domestic market.
Last April, the government altered the investment restrictions applicable to all Portuguese pension funds. “This new legislation clarifies what is considered as domestic currency. Previously, 20% of the pension fund could be exposed to non-escudo assets. Now it has been clarified that this 20% is for non-euro assets,” says Guerra.
According to Bernie Thomas at consultants Watson Wyatt in Lisbon, this legislation has narrowed investment choice, not also in terms of outside investments, but also in the equity market. “When the government introduced what we perceive as a limitation for investment, there was not a huge reaction in the market. Portugal does not yet have the Anglo-Saxon culture that equities is the only way to go on pension funds. It is much more like France, Germany, Italy or Spain, where there is still a very strong bond culture.”
The Portuguese equity market performed very well during the past three years, but the returns so far this year have been pretty bad. During the first six months of 1999, the average performance of segregated funds was 0.8%, differing significantly from the corresponding period of the previous year.
From 1985–95, pensions funds were returning from 10% to even 25%, due to high interest rates and high inflation. After 1995, with inflation brought down to unprecedented levels to allow entry to the euro, the stockmarket boomed, with returns between 15 and 20%. But now everything has changed.
Fund managers are worried because they know they are not doing as well as European managers and therefore they see a potential threat to their businesses. “The Portuguese equity market is going down, and the European one is going up. The gap is getting bigger and bigger, but it is not going to carry on expanding forever. At some point in time, Portuguese equities are going to become so cheap that they will have better value than European equities,” says Thomas.
A new law on pension funds has been approved by the cabinet and is expected to be published in the near future. This new law is not a massive reform in itself, but it is a first step towards future reforms.
The new legislation does not actually focus on investments but on the contractual relationship between the actuary, the plan’s sponsor and the fund manager. It allows pension fund companies and insurance companies – the only entities that can manage pension assets in Portugal – to sub-contract actuarial, international management and administration services to third parties, which was unclear under current law. It also defines conditions under which a surplus in a fund may be returned to the sponsoring company. Although these conditions are not easy to meet, they are less extreme than the criteria being applied at present.
Francisco Campilho, at Victoria Seguros in Lisbon, comments: “The changes of the new law are not as many as we expected but it clarifies some rules and gives more transparency. Things will not change too much for us, but we hope the new legislation turns the pension fund market into something more attractive. People need information to increase their interest in this issue. At times of bad performance, it is very difficult to tell people that they are not going to get any returns. Our clients were used to very high returns, which were extraordinary and will not happen again.”
The new law also requires that members of a defined contribution plan receive regular information concerning their benefit entitlements. Although the DC-DB debate is not yet as vivid in Portugal as it is in other countries, it is already taking place within multinational companies. Large domestic funds, such as the banking funds, which are very big in Portugal, are negotiated through a collective agreement that remains firmly as a DB arrangement.
However, fund managers are realising that there is a trend to DC schemes and investment choice is becoming a very important issue for companies. They are struggling to offer products that will enable employees to choose among different risk profiles within the pension fund market.
According to Watson Wyatt, at June this year, the average asset allocation of segregated funds was 17% in fixed rate Portuguese public debt, 36% in other eurobonds, 20% in Portuguese equities and 7.5% in other euro-equities, which at the end of last year represented only 5%.
Nuno Botelho of Mello Activos Financeiros believes investment choice is increasing in terms of asset allocation. Mello, which at June 1997 had 6% of equities outside the domestic market, now has 15% invested in euroland, 10% in Portugal and 10% in other markets. Botelho thinks this trend will continue, although “being a small fund makes it difficult to diversify portfolios as we can’t invest directly in markets such Asia, US or sometimes even Euroland”.
These changes in asset allocation and investing trends explain why the Portuguese domestic market has been quite depressed this year. “The global trend of using a sector approach when investing has affected our domestic market. Our economy is not strong in some of the sectors which best performed during this year in the stockmarkets such as petroleum or technology,” Botelho says.
Another limitation for fund managers is the concentration of the market. As banks merge the number of providers is shrinking dramatically. Whereas five years ago you could choose among 10–15 fund managers, now the choice is being cut down and it may be narrower in the future. Botelho says: “We have a very concentrated market, with seven pension funds controlling 70% of the market.”
All fund managers agree on the need for a reform of the social security system. The level of benefits provided for social security in Portugal is too high for what the country can afford. Reform will come but nobody knows when.
Francisco de Medeiros Cordeiro, secretary general of the Associação das Empresas Gestoras de Fundos de Pensões (AEGFP), says that, “our social security system is still very generous, providing up to 80% of salary on retirement, reaching 100% for civil servants. At the beginning of the year, parliament started discussing four proposals for a new legal framework for social security, but they have not agreed on a reform as yet.”
Jorge Carriço of Instituto de Seguros de Portugal (ISP) says: “Social security reform and more tax incentives are necessary for the growth of the market. The Portuguese market is developing at a very fast rate, and it is our duty to accompany this development. We advise insurance companies and pension funds in areas where they have problems and the legislation issue is one of them.”
Despite all the limitations, managers agree that the services they are providing are becoming more specialised, sophisticated and competitive. Sofia Frère of Banco Santander de Negócios Portugal believes that a better knowledge of the domestic market is helping it deal with cross-border competition. “We are a Spanish bank based in Portugal. Our team is mainly Portuguese so we know the market. But also we benefit from a very good international knowledge, as we belong to an international group with a strong presence in Europe and Latin America. I believe it is a good moment to invest in our domestic market, not only for Portuguese investors, but also for European managers.”
However, some comment that there is a lot to be done. “It is not only to do with the fund managers themselves, it is the regulation that is not allowing them to work,” says Watson’s Thomas.