Over the past 10 years Portuguese governments of both centre-left and centre-right have made considerable progress in liberalising pension fund investment regulations.
“A decade ago there was a limit of 10% exposure to equities,” recalls Bernie Thomas of Lisbon-based consultancy Watson Wyatt. “That has now been increased to 55% and can go higher if a fund can show the supervisory authorities that it has undertaken an asset liability study and that the plan sponsor fully understands the risks that are involved in having high equity exposures.”
And this flexibility is echoed elsewhere in the pensions arena. “Regulatory limitations are more to do with investment vehicles and whether they are quoted, than with asset class,” says the head of investments at a closed pension fund who does not wish to be identified.
“Portuguese regulations are not more conservative than those found elsewhere in Europe and it is within the spirit of the regulation to make a case showing that, with a liability profile, a different asset allocation strategy would be good for the pension fund.”
But Isabel Semião, an actuary with BPI Pensões, the pension fund manager of the BPI banking group, finds that a recent change to allow the placing of up to 5% of a fund in ‘non-harmonised’ assets, which appears to put a cap on all alternative investments including hedge funds, is too restrictive. “We would prefer to have a 10% ceiling,” she says.
“The motivation behind the liberalisation moves was to further a move to bring Portugal in line with the rest of Europe,” says Thomas. “The government wants to make the rules more flexible for market economies to operate in.”
Private provision is still quite small but growing and the government is drafting regulations to promote the second pillar, allowing workers to choose private investment for a part of their contributions, which should be passed this year.
The pension funds market totals about E15bn, with plans tending to be company-focused not industry-wide and largely consisting of pension funds for multinationals, former public enterprises that were privatised and have retained and manage their own pension funds, and the banking system. The banks account for more than half of the total, with banking employees having collective agreements with their employers instead of the normal social security benefits. So, taking the banking sector out of the picture leaves a relatively small top-up to the social security universe. There is also a third pillar, the PPR.
For the sector as a whole the average weighted return in 2003 was 8.3% and the median return was 7.4%, the difference being that the former is weighted by the size of the fund while the median return simply ranks all of the returns irrespective of how big the fund is and just takes the median of that.
Asset allocation at the end of the first half of 2004 saw very little change overall from end-2003, exposure to equities rising to 29.8% from 28.8%, property 11.8% from 12%, cash and money market 8.1% from 7.6%, and alternatives/funds of hedge funds 1.6% from 1.5%. The rest is bonds, typically euro-denominated and split roughly evenly between government and corporate debt.
But within that overall picture there were wide variations. Miguel Branco, head of performance measurement at the Fundo de Pensões do Banco de Portugal, the central bank of Portugal’s defined benefit corporate pension fund, notes that it pursues a conservative investment policy. “We have not ignored that equities have been particularly risky in the last four years, more risky than in any other period in the fund’s history,” he says.
“Bond performance was the main driver of the fund total performance in 2003, which saw a return of 5.3% nominal, with the end of the decline in long-term interest rates and the stock market recovery being the highlights of the year. Equity market behaviour in 2004 has been somewhat disappointing compared to the moderate optimism that appeared to be the predominant investor sentiment at the beginning of the year.”
The bond portfolio is mostly sovereign Euro-zone bonds, with additional OECD debt, but equities are world-wide. In addition, the portfolio has a substantial real estate weighting.
“We have experienced good progress in pursuing our financial goals which are mainly liability oriented,” says Branco. “Our primary focus is on the evolution of the funded ratio. Asset performance has been highly dependent on interest rate movements.”
A rise in interest rates would not automatically drive Fundo de Pensões do Banco de Portugal into equities. Its focus on asset liability management means that it is somewhat insulated against interest rate rises. In such a situation, bonds fall but its liabilities do so too since they are marked to market, meaning that its value is discounted using government bond yields.
However, BPI Pensões made considerable changes to its asset allocation last year. “We increased equity exposure and reduced that of fixed income,” says Semião. “In fact, a comparison of our median portfolio asset allocation at the beginning and end of 2003 shows a decline in fixed income to 30% from 40%, a rise in equities to 30% from 10%, a halving of cash to 5% from 10%, a fall in the floating rate to 20% from 30%, no change in real estate at 10%, and a move into hedge funds to 5%.”
Last year ‘s recovery in performance indicators saw BPIP being ranked first in the 2003 surveys by Watson Wyatt, where its return of 13.2% outperformed the calculated market weighted average return of 8.3%, and of Mercer, where BPIP’s 9.3% topped the market median return of 7.8%.
Looking to the future, the industry consensus is that Portugal is already in line with the European pensions directive’s prudent person requirement. There is barrier where funds money invested with a fund manager outside the country loses its tax benefits, notes Watson Wyatt’s Thomas.
“But the government is aware of the need to amend tax legislation to allow greater flexibility for monies to move across Europe with much greater freedom”, he adds.
Branco of the Banco de Portugal pension fund expects to see “asset-liability financial objectives reinforced and the accuracy of the valuation of fund liabilities increased, bringing regulation more in line with the practice of pension funds that have been pursuing ALM techniques based on mark-to-market liabilities valuation.
“Another relevant change will be the expected adoption of capital adequacy requirements. This reinforces sponsors commitment to the actual risk profile of the investment policy. In addition, the fund’s long-term solvency becomes less vulnerable to the risk of the investment policy.”