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Impact Investing

IPE special report May 2018

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Poland and Hungary test investors' nerves

Alongside the economic reforms that the Polish government introduced last year were a whole raft of pension reforms aimed at overhauling the system by 2004. So far the government’s plans seem to be on track, and the asset management industry is playing a major role in moving things along. Although macro figures have been generally in line with expectations, investors have had to show patience during the past 12 months as the equity market has shown a volatility often found in emerging markets following on from a good year.
Alexander Dimitrov of East Fund Management in Vienna says it has been a very difficult year for the Polish exchange and managers have had to tread carefully. “Although most funds are reluctant to take up their foreign stock allowance, in the past central and eastern European funds have occasionally looked to their neighbouring exchanges when domestic markets have stalled. Last year, however, Hungary was probably the worst performer, followed by Poland and only the Czech market outperformed Poland!”
This meant that margins were hard to find, although the privatisation process in Poland and the restructuring of the banking and energy sectors did help the investment universe, which is still recovering from the Russian crisis. “All this has meant that we have seen real inflow into fixed income funds, and while the situation remains relatively volatile I would expect that to continue this year, with investors still seeing equity funds in a negative light,” says Dimitrov. “Continuing high interest rates are a big negative for the equity market, and make life difficult for asset managers.”
So far as the economy as a whole is concerned, Dimitrov says there were few disappointments, although the current account deficit may have been a little larger than anticipated. “As a net importer of oil, Poland was hit by the increases in the commodity price, and the soft euro meant that it was squeezed from both sides. Inevitably we are going to be monitoring the oil price carefully this year”
Pension funds have been seen to be important investors in both the equity and fixed interest markets, probably more so than foreign investors. “Although fund managers are necessarily wary of the equity market at the moment such investments will become more popular as the funds mature,” says Robert Nejman of the investment bank CAIB in Warsaw. He also believes that the reticence shown towards overseas stocks may be about to change. “At CAIB we have set up three funds Top Europe, Top America and Top Poland, to give managers an across-the-board choice, and the opportunity to balance their equity investment. We expect a growth of interest over the next 12 months as investment managers look for alternatives for their portfolios.”
Although overseas investment is limited to 5% it can be raised to 10% with the approval of the regulatory bodies, and many analysts believe that more funds will look to move in this direction. “The best comparison of Poland at the moment is with Greece around three years ago, or Spain and Portugal earlier,” says Nejman.
Marcin Fidecki at Hewitt Associates in Warsaw says that the pension reforms introduced in April last year have had the desired effect, with employers seeking to introduce pension schemes for their employees. A survey conducted by Hewitt Associates gave an indication of how successful the legislation has been, and shows how companies are approaching the reforms. “At the beginning of last year a handful of companies were registered with the government pension authority, but now we have 24, and hundreds more are preparing for registration,” says Fidecki. “These are both domestic and international companies, and our own comprehensive survey shows that just over 50% of medium to large companies intend to implement pension plans during this year, although a similar percentage said that they did not think the new schemes were motivating employees.” This is a matter of concern to the government, and a new round of tax incentives is being discussed in talks between the government, employers associations and trades unions.
The survey indicates that 82% of respondents felt that such schemes would improve the image of their company, and help to retain key employees, as well as provide improved conditions for employees.
Previously analysts expected the insurance companies to be the main beneficiaries of the new investment, but such policies have proved less attractive than anticipated, and Fidecki says that 70% of the registered schemes are making use of investment funds. “There has been a massive marketing campaign, and heavy lobbying of the government by some of the larger providers, and this has been a major influence. Many pension fund managers are relatively new to the environment, and marketing has played a major role in attracting pension fund money.”

Fund management fees were the subject of some debate last year. William M Mercer’s Kristof Novak points out that pension fund management fees are limited to 0.6% of total assets by law. “Obviously additional brokerage fees and banking fees increase costs. Compared with mutual funds and investment funds with fees of between 1.5% and 2.5% then these fees are relatively low.” The latter fees are expected to fall as funds grow in size, and converge with western levels, and indeed some fund sectors such as the money markets have already fallen below international levels, from the typically higher strata of an emerging market.
The role of consultants has also been more marked than was anticipated last year. “I would say that 12 months ago many observers were predicting that the consultants would not have much influence, but we have always maintained that the reforms provided the perfect environment for consultants to advise not only on the design of schemes but also on asset management. Although the schemes are in their infancy, it is clear that most managers are adopting a long-term view which can only be of benefit to scheme members.” says Fidecki. “Nevertheless, Polish funds are fairly basic, and there are few variables for consultants to analyse. Furthermore it is difficult to assess performance and prospects, although that it is to be expected at such an early stage. The hope is that a stable, transparent pension system will emerge, in line with the western European model which has been used as a template.”
Novak says that funds are being persuaded that it is a good idea to look to consultants to help their in-house fund managers. “It has been a successful year for us in the wake of the reforms, and I imagine that as these develop over the next few years we will see increased use of our services.”
As for where the funds are investing, the profile is much as last year. “Funds tend to invest in accordance with the government restrictions, although few take up the 5% of their portfolio which can be invested in foreign equities,” says Novak. “At the moment it is virtually impossible for Polish funds to invest in this way. So far as equities are concerned the investment is concentrated in the top 20 blue-chip stocks of the Warsaw exchange. Typically the maximum holding of 40% will vary during the year, according to the state of the market. At the moment most funds have reduced their exposure to equities, as the market fell over the past 12 months resulting in a negative performance in low single percentage figure during 2000, consequently pension funds have managed to outperform the stock exchange comfortably.”
So far as performance measures are concerned there are obvious problems in valuing assets at the beginning of the reform process. “During the first year comparisons are difficult, but we are now seeing things settle down, and comparisons with mutual funds are possible, and analysts are able to look at the relative performance of the funds,” says Novak.

Despite hopes to the contrary, the Hungarian economy continued to perform in a sluggish manner during 2000. In particular the equity market, continued to under-perform for the third consecutive year, this time actually doing worse than neighbouring Poland, and falling some distance short of the performance of the Prague exchange. Government figures were disappointing, and the oil price hike hit industry; while the resultant relatively high interest rates continued to hamper the equity market.
Although there were no real problems with the macro figures, in the sense that the government had taken a fairly pessimistic view, general sentiment on western markets continued to depress any optimism which Hungarian investors may have been feeling.
On the upside, pension and mutual funds continued to boast growing assets, and play an increasingly important investor role on the domestic markets. Arbrat Skrabski president of the Hungarian Association of Friendly Societies, which boasts 68 funds with some 500,000 members, confirms the figures. “Private pension funds raised HUF57.6bn (e217m) in membership fees in the year to 2000 from 2.64m members, resulting in assets totalling HUF89.8bn. In the case of the complementary voluntary pension funds, which began three years before the private pension funds, just over 1m members contributed fees of HUF55.2bn boosting capital to almost HUF160bn.

Holdings are in line with the government restrictions, although there have been moves to encourage fund managers to invest in more equities. Such holdings have been on a downward curve for the past three years, and 2000 was little different. “There were discussions between the government and the funds, during which it was suggested that the funds should take up more equity holdings, but the managers reacted in a negative way to these proposals. This was hardly surprising given how the BUX has performed this year,” says Skrabski. “Although there was a brief rally at the end of the year from the lowest point of the year, the rally did not last very long.”
At Concorde Asset Management in Budapest Boland Vilibok says that his company has increased its holdings from HUF10bn to HUF17bn over the past 12 months. Last year pension fund portfolios made up approximately 50% of this sum, and these funds now amount to some HUF8bn a slight proportional increase over the past year. “It is fair to say that it is the pension funds that are driving investment at the moment,” says Vilibok. “Until this past year the bond market had performed very well, but this has been the worst year for the market since 1994. Consequently we have seen the pension funds and mutual investment funds turn their attention to equities. Since the BUX has under performed, however, they have been forced to turn their attention to foreign stocks. Under the regulations governing their investment, funds may have up to 20% of their portfolio in overseas equities. Traditionally, they have always been underweight in this area, but circumstances have dictated a reappraisal of the situation. This is probably the major difference from 1999.”
The theme of overseas investment is taken up by CAIB’s Peter Holtzer. “We are a little less conservative than some of our colleagues, and so have looked abroad to enhance our performance. Last year we had around 15% of our assets invested overseas, with another 15% in domestic equities. This is quite low, but it was a very poor year for the BUX. The remainder is in domestic bonds, very similar to 1999. The fixed interest market was the best of all markets here, but that is not saying very much. In reality it was quite poor with yields of around 1% which was much lower than 1999, but still better than equities. Although our foreign exposure allowed us to hedge our margins, we also suffered a little in that area towards the end of the year, affecting our reserves.”
Holtzer says assets have increased slightly from last year, and this has been predominantly driven by the pension fund industry. “We are seeing a concentration of the pension fund sector, and would expect a few big players to begin to dominate.”
It remains difficult to analyse performance and make comparisons, says Vilibok. “Despite what I have said before, the bond market remains the cornerstone of investment for the funds. Consequently we have to look at how bonds have performed to get a general idea about how the funds have performed, subject to factoring in their equity holdings. Anyone who has not moved out of domestic equities will have under-performed this year, and it may be that some of the less experienced managers have been reluctant to look overseas. Conservatism will have equated to a poor performance in 2000.”
Deloitte Touche’s Zsolt Salamon says the introduction of the Global Investment Performance Standard (GIPS) in the future should help solve the problem of performance analysis. “A Hungarian version of this international standard is being prepared by outside consultants, and the government is expected to introduce legislation in the future, although no firm timetable is in place.”
Zsolt Kovacs of ING Investment Management in Budapest says that the new pension fund system has generated serious inflow over the past year. “We have seen an increase of around 60% in the assets which we manage, to around s1bn” he says. “This increase, almost in its entirety, can be put down to the pension reforms.”

So far as investment is concerned Kovacs says that the largest proportion is in the fixed interest market, but confirms that his company has stayed loyal to the domestic equity market. “Last year we held some HUF10bn (e39m) in Hungarian equities, this year that is HUF25bn (e100m), so we have actually increased our holding proportionately to around 10% of the total portfolio.”
So far as the fixed income market is concerned, Kovacs believes its poor performance is partly a result of the run out of the convergence principle which had seen rates converge with Euroland. The real return over inflation last year was 1.5%. In 1998 and 1999 it varied between 7–8%. The biggest influence on the fixed interest market last year was the higher than expected inflation figure. The main factor was the high oil price, and the consequent effect on food prices. The problems for the fixed interest market paled into insignificance, however, as the BUX was down by some 10% and 15% in dollar terms over the year.”
The role of consultants in the pension industry continues to divide managers and analysts alike. Kovacs believes there is little demand from investors for consultants in Hungary, and says that even the larger international companies are struggling because funds are reluctant to justify the fees. “Consultancy fees are quite high, and while fund management fees have been kept around the 0.4-0.5% mark, managers feel they cannot justify the extra expense.”
Salamon disagrees, predicting a change in the face of the pension fund industry. “There is a consolidation process under way, and the number of potential clients is being reduced. However, this is bringing in some of the major players as service providers, and this could well open the door to consultants. In general, I think this will be a positive move. The GIPS proposal may also create work for consultants, although when we approached some funds last year the issue of fees was raised again, and however the proposals are formulated this will always be a stumbling block for consultancy firms.”

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