Hungary: A case of bad timing
Thomas Escritt reviews the decision to introduce multiple risk portfolios for supplementary pension funds
In retrospect, the timing of Hungary's decision to introduce multiple risk profiles into its pension funds was bad for everyone.
The decision, taken in 2006, obliged the country's mandatory pension funds to offer different portfolios of varying risk profiles. The young could opt for an aggressive growth portfolio, heavy on equities, while those closer to retirement could opt for balanced or cautious portfolios, with progressively greater exposure to lower-risk fixed income holdings.
The multiple portfolio system became compulsory at the beginning of this year, after a period in 2008 when it had been optional. Funds which had yet to adjust were given until 30 June this year to complete the adjustments to their portfolios.
The timing was impeccable, forcing funds to move heavily into equities in late 2008, in the wake of the Lehman collapse, when equity markets everywhere were taking a battering.
For the government, the timing was little more welcome, as it came at just the moment in autumn 2008 when investors, spooked by the gathering financial storm, cut off all funding for the exposed, indebted emerging markets they had been so keen to lend to. For two weeks that autumn, Hungary's bond markets froze, and the country's treasury was forced to abandon repeated attempts to auction public debt.
Realising that the country's pension funds were among the few available sources of immediate funding, the regulator swiftly revised the rules. Funds were given another two years to introduce varying risk profiles, allowing them to act as buyer of last resort for government debt.
At the same time, new rules were introduced that cut funds' maximum levels of foreign currency exposure, incentivising them to buy state debt.
It was an emergency situation, which perhaps called for a fly-by-wire response. "The first we heard about this was from a newspaper," says Tibor Bedo, investment specialist at Stabilitas, the Hungarian pension funds association. "They delayed the timing of the equity switch by two years to help with government finances."
"It wasn't a question of the government forcing funds to buy state debt," says Ilona Juhasz, chairman of Stabilitas. "There was just nobody to buy government debt, except for pension funds, which receive cash inflows each month."
The funds that had been first to adopt multiple risk profiles were hardest hit, since they already had high equity exposure when the market turmoil hit.
And nor were they keen to sell at the bottom of the market. "The funds who had already made their move made few changes," says Zsolt Fulep, investment director at VIT, the sectoral fund for the electricity industry.
Nonetheless, state debt makes up a substantial share of funds' aggregate holdings, amounting to 48% of the net asset value of the mandatory funds, and 64% of the holdings of the third-pillar voluntary funds.
"Retrospectively, it was a good short-term investment," concedes Bedo, although few funds welcomed the uncertainty that resulted from the rapid changes to the regulations.
"We need to let rule changes run their course, and regulawtors should avoid changing their minds all the time."
Regardless of the regulatory climate, however, 2008 would in any case have been a difficult year, with even the low-risk fixed-income-heavy portfolios taking losses. During 2008, the only asset class that earned positive returns was foreign-currency exposure - and that was only the result of the plunging forint, which fell from all-time highs early in summer 2008 to record lows in the spring.
"We needed to explain to people why their fixed-return bonds were earning negative returns," says Juhasz.
Despite this uncertainty, few Hungarians have voted with their feet and reverted to the more traditional low-risk portfolios. Some three quarters of Hungary's pension fund capital still remains in the highest-risk growth portfolios.
Furthermore, the new system appears to have done its job. Even though all classes of fund suffered painful losses over 2008, those who had the most to lose were protected by having their savings in a lower-risk vehicle than had been available before.
"All the risk-profiles made losses," says Bedo, "with growth portfolios losing some 20% of their net asset values. But the classic, low-risk portfolios still outperformed the old unitary portfolios," he says.
The two-year extension means funds have until 30 June 2011 to adjust their holdings to meet the risk-profile targets.
The first, low-risk or ‘classic' portfolio is allowed an equity allocation of no more than 10%, with no allocation to property or other alternatives and a maximum of 10% in unhedged foreign currency exposure.
The second is a balanced portfolio with an equity allocation of between 10 and 40%, a maximum allocation of 10% to property and 3% to private equity and no allocation to derivatives.
The third is a growth portfolio with an equity allocation of more than 40%, a private equity exposure of up to 5% in total or 2% to an individual fund and an allocation of up to 5% to derivatives.
While members can choose which portfolio they prefer, few have done so and most have gone along with the age-based defaults. Those with more than 15 years to go before retirement enter the growth portfolio, those with between five and 15 years to go enter the balanced portfolio, while those with fewer than five years to go enter the balanced or ‘classic' portfolio.
After taking heavy losses in 2008, funds have recovered all their lost ground this year, a development that Juhasz regards with trepidation. "If you take the period from the first quarter of 2008 to the third quarters of 2009, the voluntary funds are all positive, and the mandatory funds are at the same level as before. It took two quarters to earn back five quarters of losses. It's too good, almost suspicious."