Baltic countries’ pensions systems keep growing and the region’s funds are diversifying. But regulatory frameworks are lagging behind, finds Carlo Svaluto Moreolo
Baltic pension funds continue increasing members and assets, but providers are grappling with many issues, including poor contribution rates and the limited capacity of local financial markets. Yet they are experimenting with alternatives, creating a dynamic investment environment.
Estonia: looking for political will
Pension fund growth is on track in Estonia. Assets under management (AUM) for second-pillar funds grew by about 18% in the 12 months to September 2015, reaching €2.4bn. Membership grew 2% to 674,315 over the same period. But increasing the participation in the private pension system remains the main concern for pension funds, says Martin Rajasalu, member of the board of Nordea Pensions Estonia. “We are not immune to demographic developments”, he explains, adding that country will suffer from its low level of pension savings, for which the lack of employer contributions is partly to blame. “We have pension regulation for employers on paper, but it is almost non-existing in reality.”
The small number of large employers, limited influence of trade unions and unfavourable tax regime are some of the other structural factors complicating the picture. “Pension taxation is the factor we can address and work with, and this has been acknowledged by policymakers, but I could not say there is political will to deliver,” Rajasalu continues.
On asset allocation, portfolios have been stable over the past year. Regulation establishes fixed limits for equity and fixed income allocations in pension funds’ portfolios, and assets are marked to market on a daily basis. Nevertheless, strategies can vary somewhat and returns over the past year have ranged between -1% and almost 9%.
While some pension funds have up to 30% of their assets in Baltic and eastern European assets, Rajasalu says the allocation is generally “very global. What we have witnessed lately is the increasing confidence in investing.” This is reflected in the declining allocations to cash.
Regulation itself is changing at the margins, with improved investment freedoms. Compared to previous years, funds can allocate more to non-listed vehicles including infrastructure, precious metals and real estate.
“We might see some developments towards alternative and less liquid investments,” adds Rajasalu, but liquidity and daily valuation requirements will counterbalance the growing risk appetite.
Latvia: communication programme
Latvia ranks second in the Baltics in terms of second-pillar assets but has the highest number of members. In 2014, Allianz ranked the country the ninth most sustainable pension system in the world but a little over a year later it put the country in 30th place. Dace Brencēna, CEO of the SEB Pension Fund in Latvia, says: “This means that technically, the system is very well designed and financially stable. But the income level is far from adequate, and something needs to be done to stimulate savings.” Brencēna explains that inflows from contributions are growing at a 5% rate, mainly due to rising salaries rather than higher contribution rates or more companies and workers joining the system. “Large companies are already using private pensions as a remuneration tool, but medium and small-sized companies really have to be pushed somehow.” Contributions are not paid on behalf of employees of state-owned companies, creating a pension gap.
The Latvian pension industry is undergoing potentially positive changes. Pension savings are going to increase faster, says Brencēna, as the statutory contribution rate to funded pension schemes is increased. Furthermore, the country’s welfare minister has launched a communication programme to explain to workers that all three pillars are necessary for a secure retirement. Still, Brencēna believes the discussion should focus on mandatory employer contributions, to increase inflows into the system and to create a saving culture.
Another major development for Latvia was the recent introduction of new rules on asset managers’ remuneration. The framework is based on performance fees and a 1% commission cap. Brencēna says: “This makes our pension funds comparable on a European level. We have a small market and administration costs matters, so commission caps and performance fees represent the most relevant approach.”
In terms of asset allocation, Brencēna notes that regulation was somewhat relaxed, to allow pension funds to invest in alternatives and riskier assets. However, the share of alternatives in portfolios is still around 2%.
Investments are spread geographically equally between Latvia (35%) and the rest of the Europe (35%), with a slightly lower allocation to global assets (30%). Pension funds, however, are looking to expand their portfolio of domestic real assets, particularly real estate and venture capital. One such opportunity came last summer, when a local energy company, Latvenergo, issued €180m worth of green bonds.
Lithuania: seeking diversification
With €2bn in AUM at the end of September 2015, Lithuania is the third in the region in terms of second-pillar assets. The country’s second pillar funds recorded 11.5% AUM growth in the 12 months to the end of September 2015, while membership grew 4.9% to 1.2m. Pension funds are classified by equity weights into conservative, balanced and aggressive allocations. They are diversifying across the board, according to Virgilijus Mirkės, CEO of SEB Asset Management.
Funds in all categories have shifted fixed income allocations from western Europe to central and eastern Europe, including Lithuania, while conservative funds have increased allocations to cash. Balanced and aggressive funds are exploiting opportunities in local private equity and real estate, using fund structures. In equities, funds are moving to global developed markets.
Both second and third-pillar pension funds took a hit during the third quarter of 2015 due to the difficult global market environment, but strong results earlier in the year kept them afloat.
In 2015, activity on the regulatory front was muted. Mirkės mentions four key topics under discussion in the country. First is the introduction of lifecycle approaches. Mirkės says: “The current system does not foresee default options, and people tend to select risk levels that are not appropriate for their age, most often leaning towards the more conservative approaches.” Changes in pension payout rules are also part of the debate, as are fee levels.
“Fees always appear on agenda from time to time. But as the equity markets rose in recent years, the parliament has been less vocal about it,” Mirkės adds. Finally, contribution levels are regularly debated, given that the state pays part of the pension contribution from the state budget. From 2020, the statutory contribution rate is scheduled to rise to 3.5% of salary.