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Pensions In Central & Eastern Europe: A fresh start for pensions

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Polish pension funds have been taking stock of a drastically changed landscape following last year’s large-scale asset transfer to the state system. Krystyna Krzyzak asseses how they have managed the process

Poland’s pension fund managers (PTEs) are now dealing with a much smaller pot of assets. The February 2014 renationalisation of government bonds shrank the aggregate portfolio by 48% to PLN299bn (€71bn) (figure 1). The switchover to a voluntary system at the start of August reduced the monthly contribution volume by over 70% – from PLN972m in July to just PLN278m in August.

Some funds fared better than others. ING OFE increased its share of contributor numbers from just over 20% to almost 24%, and contribution value from just under a quarter to 30%. For others, the gains were fractional – the second biggest fund, Aviva OFE Aviva BZ WBK, increased its share of individual contributors by 0.5 percentage points to 18%, and its share in contributions by just over a percentage to 20.6% (figures 2 and 3).

The slider mechanism – the incremental transfer of second pillar (OFE) assets to Poland’s Social Insurance Institution (ZUS) for members approaching retirement – will further deplete the funds. In November, according to estimates from ZUS president Zbigniew Derdziuk, assets worth PLN3.3bn, from around 1.3m members, left the OFEs under the slider rule. 

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The funds have to ensure that they have sufficient liquidity to meet their slider obligations. Grzegorz Chłopek, CEO of ING PTE, says his fund did not have to dispense of any assets to generate slider payouts: “We’re in a comfortable position, because we received the highest number of clients during the declaration period, 24% of our portfolio against a market average of 15%, so until the next declaration period in 2016, we should have a positive inflow. In addition, we will have inflows from interest earned on corporate bonds and bank deposits, and from dividends.”

In ING OFE’s case, retention was aided by its members’ relative high wage profile. Close to 50% of high wage earners stayed in the second pillar, compared with less than 20% in the lowest wage category. Those who signed up with the fund at the start of their first job also proved more loyal than those who subsequently transferred in.

At a glance

• A new law has now shrunk second pillar pension fund portfolios, which have become heavily skewed towards equities.

• An increase in foreign investment limits improves diversification and liquidity.

• Corporate bonds have become an increasingly popular asset class.

This loyalty, unfortunately, will prove difficult to replicate. New entrants to the labour market retain the option to choose whether to join an OFE, but few have – only 1.8% of new workers between February and September. When the system was mandatory, ZUS informed potential clients that they had to choose an OFE or be assigned to one by lottery. “ZUS created interest in the system and about 20% actively chose an OFE,” observes Andrzej Sołdek, chairman of the board of PTE PZU.  “Now we can see a difference. There is relatively little interest, and our promotional campaigns are less effective.”

What remains of the OFE portfolios is highly skewed towards equities. However, according to Sołdek, from the perspective of a combined client pension portfolio, shifting the bond assets to ZUS while raising the OFE equity portion has not altered overall risks; the ZUS accounts are indexed to GDP and wage growth. Meanwhile, although the OFE equity share has risen to up to 80%, for the combined pension portfolio it only accounts for 11-15%.

Sołdek describes the slider as a mechanism for reducing risk. “We would have preferred this mechanism to have been offered on the market, in the form of us providing safety funds, but the gradual transfer of assets [prior to retirement] immunises assets from a collapse on the stock exchange, especially for those who have already accumulated a large amount of assets.”

The 2014 pension reform law

Under the 2014 pension reform law, Polish second pillar funds (OFEs) were barred from investing in sovereign bonds, including those issued by foreign entities. In February, each OFE had to transfer 51.5% of the September 2013 market value of their portfolio to ZUS, with the bonds subsequently redeemed by the government. According to the National Bank of Poland, the value of transferred bonds totalled PLN130.2bn (€31.3bn) or 43.6% of January’s net asset value, while the subsequent redemption reduced the public debt-to-GDP ratio by 7.6 percentage points. The full asset transfer totalled PLN153.2bn.

Between last April and July fund members had to inform ZUS whether they wished to continue contributing to the second pillar or have future contributions accumulated in sub-accounts at ZUS. The latter was the default option. Over this period, fund managers were barred from advertising. Only 18% of the 14m-plus eligible workers elected to remain in the second pillar. The next declaration window opens in 2016, and every four years thereafter.

Following the failure of the pensions industry and government to devise a second-pillar payout system, the new law introduced the ‘slider’, whereby those members with 10 or fewer years left to maturity would have their second pillar assets incrementally transferred to the first pillar. The slider took effect in November.

The law also lifted the minimum return requirement and overhauled investment regulations. The equity limit was raised from a maximum 40% of net assets to a minimum 75% in 2014, thereafter falling 20% annually until 2018, when the restrictions will be lifted.

The maximum foreign investment limit was increased from 5% to 10% in 2014, rising to 20% in 2015 and 30% the following year.

The contribution rate was raised from 2.8% to 2.92%, while the maximum management fee fell from 3.5% to 1.75%.

Rafał Mikusiński, EMEA mutual and pension funds, eastern and southern Europe investment head at MetLife, concurs. “The long-term investment approach, with equity-driven portfolios, is beneficial for customers. Given high economic growth in Poland and the global low interest rates environment, such asset allocation, supplemented by corporate debt and high-yield instruments, provides funding for domestic companies and entrepreneurs which supports our country’s development.”

Meanwhile, the raising of the foreign investment limit, from 5% to 10% in 2014, then 20% in 2015, has provided diversification. “Diversification into foreign markets is one of the solutions for stable returns, while good quality credit provides smooth profits,” notes Mikusiński. “The local equity market structure is skewed towards the financial industry and, to some extent, utilities and commodities such as copper and oil. The extended investment scope provides our customers with exposure to other less vulnerable sectors that are poised for high growth, like consumer staples, technology and food producers. What makes it difficult and less efficient is the prohibition of investments into exchange traded funds (ETFs). This segment of global capital markets is already very transparent and cheap. However, the Polish regulator [KNF] still needs to be convinced about the potential for the development of the ETF market.”

Foreign markets have also increased liquidity, enabling funds to change their position quickly. As Sołdek explains, the problem with the Warsaw Stock Exchange is the relative size of the pension funds to the overall turnover: “In order to withdraw from some investments, especially in medium and small-sized companies, we need many sessions to execute those transactions,” he comments.

Foreign investment in the OFE context, however, now includes foreign companies listed in Poland, following a clarification by the KNF in 2014. As of mid-November there were 50 foreign companies listed on the WSE’s main list, (of which 22 were single listings) out of a total 467 (figure 4), and 10 (out of 431) on NewConnect, the alternative market for smaller companies. On the WSE main list, foreign companies accounted for 32% of market capitalisation. While this meant that ING PTE and PZU PTE exceeded their 2014 limit of 10%, the KNF took no action because of the impending doubling of the limit in 2015.

Outside the equity market, corporate bonds are the story for the Polish funds.

According to Fitch Ratings’ quarterly review of Polish non-government debt, as of end-September 2014, the value of corporate bonds with a maturity of more than one year rose by 37.8% year-on-year to PLN47.7bn; PLN13.9bn was issued in the first three quarters of 2014.

“The corporate bond market is not big enough to replace the government bonds in our portfolio, but it is growing,” notes Chłopek. “There is a much bigger demand from pension and mutual funds, and it’s important for our portfolio diversification.” Many of the corporate bonds are now quoted on Catalyst, the Polish bond market transaction platform, which is important from the perspectives of liquidity and mark-to-market valuation.  

“It’s a much more transparent market than it used to be in the past,” Chłopek adds. “Because, of our efforts in actively managing our bond portfolio – in readiness to answer price enquiries on both sides – liquidity is increasing. Interestingly, the liquidity of corporate bonds is now sometimes higher than the equity of the same issuer on the Warsaw Stock Exchange.”

Corporate governance 

Under the 2014 pension reform law, Polish second pillar funds (OFEs) were barred from investing in sovereign bonds, including those issued by foreign entities. In February, each OFE had to transfer 51.5% of the September 2013 market value of their portfolio to ZUS, with the bonds subsequently redeemed by the government. According to the National Bank of Poland, the value of transferred bonds totalled PLN130.2bn (€31.3bn) or 43.6% of January’s net asset value, while the subsequent redemption reduced the public debt-to-GDP ratio by 7.6 percentage points. The full asset transfer totalled PLN153.2bn.

Between last April and July fund members had to inform ZUS whether they wished to continue contributing to the second pillar or have future contributions accumulated in sub-accounts at ZUS. The latter was the default option. Over this period, fund managers were barred from advertising. Only 18% of the 14m-plus eligible workers elected to remain in the second pillar. The next declaration window opens in 2016, and every four years thereafter.

Following the failure of the pensions industry and government to devise a second-pillar payout system, the new law introduced the ‘slider’, whereby those members with 10 or fewer years left to maturity would have their second pillar assets incrementally transferred to the first pillar. The slider took effect in November.

The law also lifted the minimum return requirement and overhauled investment regulations. The equity limit was raised from a maximum 40% of net assets to a minimum 75% in 2014, thereafter falling 20% annually until 2018, when the restrictions will be lifted.

The maximum foreign investment limit was increased from 5% to 10% in 2014, rising to 20% in 2015 and 30% the following year.

The contribution rate was raised from 2.8% to 2.92%, while the maximum management fee fell from 3.5% to 1.75%.

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