Portugal's pension assets, while still modest by European standards, are growing rapidly and have risen to about Esc1,800bn ($10bn), according to Gabriel Bernardino, manager of the pension fund department at the pension industry's regulatory body, the Lisbon-based Instituto de Seguros de Portugal (ISP).

The size of existing funds has ballooned, explains Bernardino, but he does not expect the number of funds in the market to increase substantially until legislation to overhaul the social security system is implemented. Ac-cording to Rui Martins Dos Santos, chief economist at the Banco Portugues de Investimento (BPI) banking group, the government will only tackle this around the turn of the century, after the advent of the euro. In Portugal, pension funds are managed by independent companies called sociedades gestoras de fundos de pensoes (SGPFs), and, to a much lesser extent, by insurance companies.

While asset allocation minima were scrapped in 1994, the industry re-mains rather tightly regulated. The asset restrictions include the following: a maximum of 60% can be in-vested in bonds (excluding state bonds) and commercial paper; a 35% ceiling is set on investments in the stocks and shares quoted on OECD-member bourses; and there is a 20% limit of foreign currency holdings.

Earlier this year, notes John Grant, consultant at William Mercer in Lisbon, the maximum ceiling for equities was raised to 35%, of which up to 20% can be foreign. In addition, pension funds can indirectly boost their overseas holdings over and above the stipulated maximum through investment (up to another 20%) in escudo-de-nominated unit trusts, some of which may have a sizeable overseas component. For the time being, says Grant, most funds are certainly not clamouring for higher ceilings, and even the more aggressive players, multinational corporations and some large Portu-guese banks (for their own portfolios and not their clients') are comfortably working within the existing restrictions. However, warns BPI's investment director Isabel Castelo Branco, the restrictions on foreign currency holdings (now 20%) and equities (35%) won't make sense from next year onwards", as pension funds start to bump up against the maximum limits. Bernardino agrees, saying that there is already pressure, particularly from the multinationals, to boost the 20% ceiling on foreign currency holdings.

Since last year, Portuguese pension funds have seen a dramatic shift into equities, says Bernie Thomas, senior consulting actuary at Watson Wyatt in Lisbon. Watson Wyatt's mid-year 1997 survey results (covering 90% of the market) show that the average pension fund now holds 22% in equities. This compares with about 14% in 1996. William Mercer's survey of the market shows much the same configuration, notes Grant. Given that over the past five years, equity holdings ranging between 5-10% were the norm, this is a "big move, although from a small base", contends Martins Dos Santos. The survey results show that the growth in equities has come at the expense of the variable-rate bond and cash/ money market asset categories.

It doesn't hurt that the local market has been performing well. As Martins Dos Santos explains, the heavy weighting in domestic equities has been a deliberate decision, driven in large part by the fact that "prospects were better for the Portuguese market". Looking ahead, he expects the domestic bias to diminish, although the inherent preference for home-market instruments, both bonds and equities, will be hard to quell. "De-mand for foreign_equities will grow enormously over the next five to six years," he predicts.

Albeit on a more minor scale, holdings of foreign equities have risen from "2% to 4% (on average) pretty quickly," notes Grant. One factor that has galvanised the move overseas, he explains, is the knowledge that currency risk within the EU will be eliminated by the euro.

Even so, while "peer pressure" has led some smaller managers to seek some foreign exposure through unitised vehicles, those more active on the foreign side tend to be managers who already have some foreign holdings, and not those that are entirely new to the concept. While still a negligible part of total activity, says Grant, "going forward, I would expect greater exposure in foreign equities, particularly in Europe". While it is predominantly European equities that are being targeted, agrees Watson Wyatt's Thomas, interest in the US and the Far East is also demonstrated by some of the larger funds.

Generally, adds Grant, there has been a gradual accumulation of awareness regarding equities because of the attention that recent domestic privatisation issues have attracted. These have "highlighted equities in people's minds", a tendency that is reinforced by the current interest rate environment, says Hugo O'Neill, consultant to Schroders in Lisbon. "For a long time, bonds were a more attractive investment. The mentality has more recently shifted."

The drop in local interest rates, notably over the past six to seven months as Portugal falls into line with the rest of Europe in the run-up to EMU, has been an important factor in spurring pension funds to reduce their bond holdings and sniff around for better returns elsewhere. Gone are the days of 17% bond returns, and Portuguese long-term (10-year) bonds are now returning less than 6%, says Thomas. In fact, he adds, Portuguese and German bond differentials are diminishing rapidly.

Furthermore, funds are now in-creasingly being managed by, as O'Neill terms it, a younger generation who are actively seeking to diversify the portfolios and more apt to consider cross-border investments. Overall, however, "inertia remains a powerful force" and the average portfolio remains "way below the maximum on equity ceilings".

Since the mid 1990s, the second major trend in asset allocation has been the move from variable to fixed-rate bonds. This is largely a reflection of the government's policy of switching to fixed-rate public debt issues, claims O'Neill, and the pension funds have bought heavily into these instruments. A change in attitude is also apparent, adds Thomas, and "with Portuguese fund managers realising that the days of investing in variable bonds are over, the move into fixed-rate instruments is just one reaction". Another is the need to diversify to boost returns.

Legislation is being prepared that will make the 1991 law on pension funds more flexible and easier to amend, specifically as regards investment restrictions, explains ISP's Bernardino. "Limits won't undergo any big changes, however," he adds.

Diane Hallock is a freelance journalist"