Portugal: Choppy waters

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Portugal’s pensions sector is negotiating uncertain waters, writes Gail Moss

At a glance 

• Equity and real estate holdings are largely domestic, while fixed income has a foreign bias.
• Funds are increasing exposure to equities and alternatives to combat low interest rates.
• Listed options and exchange-traded funds (ETFs) are among investment tools being introduced into client portfolios.

The government is still pursuing measures to improve fiscal stability, as part of the conditions for the EU bailout, with further cuts to public pension benefits expected after October’s general election. The after-effects of last year’s collapse of the Banco Espirito Santo (BES), one of the country’s largest financial groups, are still being felt. And the spectre of Greece hangs over the whole of southern Europe.

However, in terms of asset allocation the response has gradual rather than sudden. Figures from the Portuguese Association of Investment Funds, Pension Funds and Asset Management (APFIPP) show the dominant asset class is still debt. The overall breakdown (including assets held indirectly within investment funds) is roughly 52% in debt, 21% in equities and 14% in real estate, with the rest largely held in cash.

Directly-held debt made up 45.6% of portfolios as at 30 June 2015. This was split between 28.6% in public debt and 17.0% in corporate bonds. Directly-held equities made up 9.5%, with 8.3% in real estate and 11% in cash, down from its spike to 16.8% at end-2014. There was also 25.5% in investment funds (about 10% equities, and 6% each in bonds and real estate). 

APFIPP says the past few quarters have seen an increasing exposure to both public and private bond markets at the expense of equities and real estate. However, some asset managers have been swimming against the tide. BPI Gestão De Activos (BPIGA), which manages the pension fund portfolios for BPI Vida e Pensoes, has been trimming the bond weighting in its institutional portfolios, while lowering its fixed income maturities. Floating-rate note holdings have also been increased, with less now in fixed-rate notes. 

José Luís Borges, head of institutional client portfolios, at BPIGA, says, “We have introduced the use of listed options both in fixed income and equity allocations because of uncertainty over the Greek situation earlier in the year, and also the relatively low option premiums we were able to get at the time. We have also increased the use of alternatives, more specifically equity long/short market-neutral funds. And we made an allocation to Japanese equities in late 2014.”

José Veiga Sarmento

In fact, he says, Portuguese funds have been getting their best returns so far this year from European and Japanese equities.

João Eufrásio, head of institutional portfolio management at BMO Global Asset Management Portugal, says: “We have slowly moved to underweight in fixed income, while still preferring credits over govvies [government bonds]. However, occupational pension funds have also found another source of income in Portuguese government bonds, taking advantage of higher investment yields or available capital gains.”  

But overall, BMO Global Asset Management has maintained a bias towards equities for over two years.

Eufrásio says: “While this stance still holds, as we run into the third year of the equity rally we have recently adopted a neutral allocation for this asset class. Geographically, we now prefer Continental Europe and Japan over the US and UK.”

The latest figures (31 December 2013) from the Portuguese Insurance and Pension Funds Supervisory Authority (ASF) show 60% of directly-held equities are Portuguese stocks, with 34% from other EU countries. 

But other asset classes show a foreign bias: about 33% of government debt held directly is Portuguese, with 65% from the rest of the EU. Nearly half (48%) of corporate bonds are also from the EU, with 42% from Portugal.

Pension funds also diversify geographically by using investment funds. Almost 79% of assets held this way are EU-based, with domestic assets making up nearly 17%.

For some years, peripheral country debt has been a way to boost fixed income returns at a time of low interest rates, depending on the pension fund’s risk tolerance. But economic problems, in particular the Greek debt crisis, have placed a question mark over the debt issued by some Mediterranean countries.

Many Portuguese funds have Spanish and Italian government bonds, says Gert Verheij, senior investment consultant, at Towers Watson Lisbon, with some still holding Portuguese paper.

However, he says: “They have been out of Greece for two or three years, although they will still have to tackle the volatility in European markets caused by Greece’s problems.”

Gert Verheij

Borges says that the crisis has not affected clients, since other peripheral countries are perceived to have a different – that is better – prospectus than Greece. 

But he says: “We were more cautious on equity allocations because of the uncertainty associated with the Greek referendum and the Greek debt crisis in general.”

In August last year, Portugal had its own mini-crisis, with the collapse of the Banco Espirito Santo. 

Eufrásio says: “The impact was more important since in this particular case, the perception of risk was totally dislocated. As time passes and the perception that the radar is now fine-tuned – both by asset managers and the supervisory body – and is more able to detect this type of situation, confidence is slowly being restored.”

As with other countries, a big influence on asset allocation by Portuguese pension funds has been continuing low interest rates. 

Eufrásio says: “Allocation to equities has been key in weathering an environment where returns are suffering from prolonged low inflation and interest rates. The impact of quantitative easing will be different in defined benefit or defined contribution schemes, but both types will need other sources of income. So far, the equity market has provided some relief to low investment yields.” 

Borges says: “Plan sponsors are concerned with the future returns of fixed income assets and are considering alternatives. So far, there has not been a material change in investment policies, but we know some are considering diversifying away from their current euro-zone fixed income allocation – for example, by increasing exposure to fixed income assets in other currencies, and also considering increasing investment in alternative strategies.”

But Verheij says: “Long-term interest rate risk is hardly being discussed. Pension fund managers are just buying short-term bonds, and we see a liability-driven approach only in a few cases.”

Meanwhile, in spite of measures such as cutting public pension benefits and increasing the retirement age, no attempt has been made by the government to encourage second or third pillar saving.

José Veiga Sarmento, chair, APFIPP, says the government should give clear signals to workers on what they can expect from their future state pension, offering adequate incentives for retirement savings, both at individual and employer level. 

João Eufrásio

He says: “The lack of such incentives, together with the still fragile situation of the Portuguese economy, does not favour the creation of new workplace-related pension funds, and therefore second pillar pension plans remain an insignificant part of the pension funds market.”

Turning to the outlook for the next 12 months, Veiga Sarmento says: “Continuing low levels of interest rates will favour investments in securities with a higher risk/reward profile, such as equities and high yield bonds. Meanwhile, almost all of the real estate assets are domestic, and with the Portuguese real estate market showing signs of recovery, it is possible that pension funds will reinforce their investment in this asset class.”

Eufrásio says: “We use exchange-traded funds (ETFs) in our client portfolios, and although their exponential growth is likely to ease a little, these instruments will continue to play an important role within portfolios, but the style is set to change. It is expected that smart beta trategies will be used more by occupational pension funds. The investment policy guidelines of the occupational schemes are also likely to be more open to embrace asset classes so far not on the radar. These types of changes are already happening, but could accelerate in the next year or so.”

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