New Europe shows potential
Central and east European asset management markets are currently among the fastest growing in Europe. The markets are skewed by the compulsory private pensions system, which distinguishes the region from the ‘old’ EU, but growth is most rapid in the investment fund market, albeit from a low base. According to the European Fund and Asset Management Association (EFAMA), Slovakia, Hungary and Poland were among the top five countries in terms of UCITS asset growth in the first half of 2005.
In Hungary the investment fund market totalled HUF1,877bn (o7.5bn) as of the end of September 2005, according to data from BAMOSZ, the Association of Investment Fund Management Companies in Hungary. BAMOSZ members have an additional o9.1bn in assets under management, including o5.3bn in pension funds, o2.4bn in insurance assets and o751m in unit-linked products.
The investment fund market has grown strongly, by 76% in forint terms since the start of the year, consolidating the share of the fixed income sector: together money market and bond funds accounted for more than 70% of all investment.
Retail investors, some 75% of the investment fund market, continue to favour these products, aided by recent falling interest rates that have made bank deposits uncompetitive. “The Hungarian bond markets performed well in the first three quarter of 2005, although with an election due in 2006, there may be a correction,” observes Peter Holtzer, CEO of OTP Fund Management, the country’s largest pension and fund manager. As a result of spectacular performances by the Budapest Stock Exchange and in Warsaw and Prague, equity fund investment was up by nearly 60%, although as a proportion of total funds the class still accounts for less than 9%. According to Holtzer there are also an increasing number of capital guaranteed funds, around 30 as of the end of 2005, with the more recent introductions linked to commodities such as oil and gold.
As in 2004 the big drive, says Holtzer, has been into real estate funds, with Hungary the most developed country in central and eastern Europe as far as this asset class is concerned. Real estate funds totalled o1.1bn as of September 2005, a rise of nearly 170% since the start of the year, and are now more popular than equity funds in Hungary. Holtzer, however, cautions that because of the recent high inflows of money into these funds the cash portion remains high, and there are also questions about portfolio valuations that the financial regulator is now examining.
Despite EU accession and the ability of EU-domiciled companies to market into Hungary, there is little interest from either investors in foreign funds or foreign fund managers entering the market. “One of the features of the Hungarian market is our very low distribution fees, which is a barrier to foreign firms. They also want to sell equity-linked products,” adds Holtzer. “Hungary is still a bank-dominated market with a closed architecture. We don’t have independent financial advisers, and internet sales are not significant.”
Traditionally the Czech market has also been focused on fixed income. Data on the Czech market comes from two sources, UNIS, the Union of Investment Companies of the Czech Republic, which represents investment fund managers of Czech funds, and AKAT, the capital market association representing foreign fund distributors. As of the end of September 2005, UNIS funds totalled CzK130.6bn (o4.5bn) and AKAT funds CzK84bn (o2.9bn). As of September 2005 money market funds accounted for 55% of UNIS member funds and bond funds 21%. In the case of AKAT members the respective percentages were 36% and 20%.
“But we’re reaching the bottom of the interest rate cycle,” observes Josef Benes, CEO of CSOB Asset Management. “In November the central bank raised interest rates, since when there has been an outflow out of fixed income into capital guaranteed products.” Capital guaranteed funds, which CSOB launched in the Czech market four years ago, now account for 30-35% of the total market’s investment fund sales and 50% in CSOB’s case. For historical reasons Czech investors remain relatively risk averse, with a short horizon of two to three years. Equity funds account for 6% in the case of locally domiciled UNIS-member funds but a significantly higher proportion, 21%, when it comes to AKAT-distributed foreign funds – despite the significantly higher yields.
Czech fund legislation has generally come in line with that of the EU. “The vast majority of foreign and Czech-domiciled funds have a local passport, and the collective investment law is also nominally harmonised, but the UCITS-3 harmonisation directive is broad and widely interpreted,” notes Benes. Consequently the Czech legislature is finalising a new amendment to the collective investment law. Currently in its second reading in parliament, the amendment should hopefully be passed by March 2006. It will allow for special products, such as hedge and real estate funds, aimed at the sophisticated investor. The definition of “sophisticated”, which generated much debate, includes a minimum investment of CzK1m.
Other related legislative changes include the merging of the Securities and Exchange Commission, which currently regulates investment funds, into the Czech National Bank; the latter will become the country’s pan-financial regulator. As the fund industry will have one representative on the seven-member council, this move is providing added impetus for the two self-regulating bodies, UNIS and AKAT, to merge.
The other predicted effect of EU harmonisation, that of a foreign influx, has, as in Hungary, been more muted. In the Czech market the interest from newcomers lies mainly in private wealth management. The retail market, which requires branch network infrastructure, is already saturated and dominated by the three big local banks, CSOB, Ceska Sporitelna and KB, each with a massive base of depositors into which they can cross-sell. According to Benes there is no culture in the Czech market for third-party sales of funds.
The other main sector of the Czech asset management industry is the private pensions industry, with assets of around CzK126bn. Unlike other countries in the region the Czechs have resisted a second pillar pensions system to date, but in the run up to the 2006 elections most political parties appear committed to reviewing this.
In neighbouring Slovakia there has been a long established private pensions market, and a second pillar scheme that started at the beginning of 2005. In the investment fund industry, assets under management as of the end of October 2005 stood at SKr126.3bn (o3.2bn) - a year on year growth of 56% in Slovak crown terms - of which open-end fund management accounted for o3bn, closed-end funds o36m, and discretionary fund management o175m. It is a highly concentrated market, with three companies, Tatra Asset Management (TAM), Slovenska Sporitelna and VUB accounting for 75% of the total. As in the Czech Republic, there is a high focus on fixed income, with money market funds accounting for 45% of open-ended funds and bonds 37%, equity 6% and mixed funds 8%. As Martin Duriancik, portfolio manager of Tatra Asset Management, explains, “the domestic bond and money markets performed well on the back of interest rate cuts. Because of the strengthening of the Slovak crown, there was good foreign investor sentiment on the region, and investors gained well on conservative products.”
Capital guaranteed products, as in the Czech Republic pioneered by CSOB, are also available, while further changes in legislation in the first quarter of 2006 will open up the market for real estate funds.
The current interest, notes Duriancik, is in fund of funds, which until recently had only been available on the Slovakian market from foreign owned entities. As of the end of October 2005 there were 29 such funds with total assets of SKr3.9bn compared with 21 and assets of SKr284m at the start of the year. TAM itself launched three of these earlier in the year for private investors and a further three in September 2005 for retail investors, the latter with equity profiles of 20%, 40% and 60% respectively, and Duriancik describes the product as TAM’s core strategy in the future. According to him, unlike most of the foreign-launched fund of funds, TAM’s are hedged for currency risk. “Fund of funds offer value in the future - a higher risk profile - and include assets not that widely available from bank branches,” he explains. “They are easy to buy, and we manage the volatility, using an active asset allocation model, so that investors with a three-year horizon have a 95% confidence level that they will not lose money.”
In the region’s largest market, Poland, harmonisation of EU legislation has also created some important changes in the market. One of the effects of the relevant legislation, which came into effect in July 2004, was that investment fund companies, upon SEC authorisation, could manage not only the assets of investment funds but also those of private clients. In practice the earlier stricture meant that for cost reasons many investment fund companies set up separate asset management companies for that side of the business, and were only involved in the creation and administration of the funds. Currently Poland has 26 authorised asset management companies, of which seven are investment fund companies.
The July 2004 law also allowed for more flexibility in products, including umbrella funds. As of October 2005 switching between sub-funds in the umbrellas became exempt from capital gains tax, and according to Krzysztof Lewandowski, head of strategy and development at Pioneer Pekao Investment Fund Company, if the tax regime remains unchanged, this would provide an impetus for more funds to convert to umbrella structures. Some of the newer structures taking advantage of the increased product flexibility include real estate funds and securitisation funds. The latter, which invest in distressed assets such as loans, have so far been offered only as private placements.
In Polish asset management, the largest sector is the second pillar pension programme, which had assets of PLN80.5bn (o20.6bn) as of the end of the third quarter of 2005. The Polish investment fund market totalled PLN54.2bn (o13.8bn) as of the end of October 2005, a year on year growth of 59% in Polish zloty terms.
Fund managers associated with banks and their captive distribution dominate this market because of their branch networks. “Even before Poland joined the EU, the players who wanted to be in the market had already established themselves,” says Krysztof Lewandowski. Pioneer itself is longest established and biggest investment fund manager, with around o4.5bn of assets under management, or 35% of the domestic fund market.
As a result of EU accession, there are an additional 200-odd offshore-registered funds that can be distributed in Poland, although there is no ready data on these. These would tend to be distributed through brokerages and the recently established independent financial advisers.
In the pure fixed income market, Polish bonds account for 21% of net asset value, money market 15% and foreign bonds, mainly US dollars, a further 8%. Although pure Polish and foreign equity funds account for only 9%, funds that include an equity component - the so-called mixed or balanced funds where the percentage can range between 40-60% and stable-growth funds which have up to 40% in equities - are popular because of their inherent diversification, and accounted for 15% and 22% of net asset value.
“The typical Polish investor is risk averse, so fixed income funds remain popular,” notes Lewandowski. “On the other hand we are probably at the bottom of the interest rate cycle and asset managers are pushing investors to take a slightly higher risk. They compromise at balanced and stable-growth funds.”
Pioneer recently launched three mixed funds with proportions of 20%, 40% and 60%, with the 40% equity component fund currently the most popular.
Slovenia’s fund industry has consolidated since 2003 as the former privatisation funds were forced to convert to either mutual funds or investment companies. As of the end of October 2005 assets in mutual funds totalled around o1.2bn, a year on year rise of 40%, and those in investment funds o890m, a fall of 26%. Funds with an equity component, including balanced funds, remain the most popular because of the continuing high rise of the Slovenian stock market and continuing inflows of shares as a result of privatisation. There are around 100 foreign funds registered with the Slovenian Securities Market Agency, mainly from Austria, although Italian and French registered funds are also popular.
A predilection for equities is also a component of the Baltic markets. In Estonia, investment and pension fund assets under management totalled EEK14.2bn (o908m) as of the end of June 2005, a year on year rise of 31%, according to data from the Financial Supervision Authority. Of these, mandatory pension funds accounted for 24%, voluntary third pillar pension funds 2%, equity funds 39% and debt funds 35%.
Under Estonian legislation investment fund companies manage both pensions and investment funds. Investment in both pensions and other funds has been spurred by rising disposable income, with 90% of the workforce now enrolled in the second pillar scheme despite the fact that it is only compulsory for new entrants to the labour force. Currently the funds compete for this disposable income with the mortgage market, which has boomed in recent year, and where real interest rates, effectively negative, are the lowest in Europe.
Investment funds have been available in Estonia since 1995. “Since 2002 investment fund business in the Baltics has been dominated by east European mandates, because the local stock exchanges are very small; we call it ‘home bias’,” notes Robert Kitt, fund manager of Hansa Pension Funds. In Estonia the proportion of equity funds as a total was 39% as of mid 2005, compared with 15% a year earlier. Geographically, according to the financial authority’s data as of the end of September 2005, only 17% of local equity fund investments were of Estonian origin, with Polish securities accounting for a similar percentage, Croatian 13% and Russian 10%.
The need to diversify geographically confirms the recent trend in Estonia for fund of funds. “We can maintain the home bias,” adds Kitt. “Fund of funds provide global diversification, wider selection and a lower expense ratio as we can purchase institutional amounts of shares.” Swedish-owned Hansa, which is the biggest pan-Baltic player (it manages 55% of the second pillar funds in Estonia, 42% in Latvia and 40% in Lithuania), also offers its equity funds into Finland and Sweden, where they attract significant interest according to Kitt. Estonia’s investment law is due to be amended in February 2006, allowing for real estate, private equity and venture capital funds.
In Latvia, as of mid 2005 there were nine investment management companies managing between them 13 open-end and four closed-end funds. In addition eight foreign funds had been registered to trade. Net assets of Latvian funds totalled Lats59.8m (o85m), a year on year rise in lats terms of nearly 100%, according to data from Latvia’s Financial and Capital Market Commission, the regulator for the pensions, securities and investment fund industries. In pension fund market, second pillar net assets totalled Lats65m, and third pillar Lats30.3m.
Sergey Medvedev, president of Parex Investment Company, Latvia’s biggest investment fund manager by asset market share, attributes the fast growth in Latvian investment fund business to an increase in new funds being registered and improved bank distribution channels for the retail market, including the internet. In addition, Latvia’s high inflation rate (at 7.7% in October, the highest annualised rate in the EU) has made it increasingly unattractive to leave money on deposit. “If investors keep their money on deposit they are getting a negative real return compared with a real return of 3% from investment funds,” explains Medvedev. “The high inflation rate has been good for our business: it forces people to think about their savings and has made them proactive.”
Fixed income accounts for 88% of Latvian investment fund securities and shares 11%, while geographically Latvia accounts for 48% of the investment portfolio, Russia 20% and Poland and Ukraine 4% apiece. According to Medvedev, investors are increasingly willing to invest more aggressively. The Baltic index has risen by more than 40% since the start of 2005, and there is also more interest in Russian equities. “Most of the interest in 2005 has been in balanced funds fixed interest and_equities, which have produced a good annualised performance of around 10%, and are not that volatile,” he notes. “The balanced and equity funds are primarily invested in central and eastern Europe.”
For Latvian asset managers, the most interesting legal developments are taking place in the pensions arena. Latvian private pension funds can now take residents from other EU countries as members. The local pension funds can also appoint EU-registered asset managers and custodians. “In practice little has changed because the market is small and not attractive to foreigners, but the ability to raise members from abroad could lead eventually to one pension fund registered in one country, and benefit big international players,” says Medevedev. A further change set for 2006 is the state treasury, which was the original asset manager when the second pillar started in 2001 and which still had some 22% of assets under management as of November 2005, has to prepare by 2006 to hand over its mandates to private asset managers.
Lithuania’s asset management industry has lagged behind Estonia’s and Latvia’s because of late implementation of legislation, but it is now making up for lost ground. A UCITS-compatible law allowing for mutual funds came into effect in 2003, while the second pillar pensions scheme started operating the following year. According to Saulius Racevicius, president of Lithuania’s Association of Investment Management Companies and managing director of Sindicatum Capital International, the London-based investment company, assets under management as of the end of October 2005 totalled Litas1.14bn (o329m), a rise of 66% since the start of the year. Of this, the second pillar pension accounted for Litas270m. In the investment fund sector there were 18 Lithuanian-registered UCITS funds and 23 EU cross-border UCITs managed in other EU countries, including some umbrella funds.
As in Estonia and Latvia, the interest in equity is more pronounced than that elsewhere in the region, with central and east European equity funds currently the most popular. The clientele is largely richer individuals, but as Racevicius observes, “as the number of investors grows, there will be a shift from riskier investments to more mature markets”.