Central and eastern European pension funds continued to climb up the Top 1000 ranks, with asset growth last year outstripping that of membership because of the exceptionally strong performance of the local capital markets.
Share prices rocketed ahead of EU accession in May 2004, while bond markets posted some of their best returns because of falling interest rates, which continue to converge with those in the Euro-zone. In the larger, more mature markets, like the mandatory pension funds in Poland and Hungary, and the voluntary Czech and Slovak funds, assets in euro terms grew by 60%, 67%, 32% and 47%, respectively, boosted by local currency strengthening against the euro.
Economic factors such as strong growth and falling inflation played a greater role in fund growth than asset allocation, which in any case varies widely across the region, partly conditioned by local regulations. In the Baltic States, for instance, fund managers have to offer at least one so-called conservative fund dedicated purely to bonds and designed for older members, as well as one or more funds with a greater weighting in equities for members prepared to take a greater risk. These funds are among the smallest in the region. In most of the region’s larger countries fund managers can usually offer only a single mixed fund, which certainly boosts size but potentially also creates problems for members close to retirement if it coincides with a downturn in the equity market.
Overseas exposure also varies markedly. At one extreme Estonian pension funds have no limit as there is little government bond market to speak of – by law budget deficits can only be set in exceptional circumstances – and the stock market is small and shrinking. Foreign strategic investors are progressively delisting their acquisitions from the Tallinn Stock Exchange. In spring, Hansabank, the largest banking group in the Baltics and the exchange’s most liquid stock, was delisted following Swedbank’s buy-out of minority shareholders, and Estonian Telekom is set to follow.
At the other extreme Polish mandatory pension funds can only invest a maximum 5% overseas. “We want a better exposure to the European capital market,” says Piotr Szczepiorkowski, chief executive officer at Commercial Union Pension Fund Company, part of the Aviva group, which manages Poland’s and the region’s largest pension fund at e4.3bn.
“This 5% limit should be increased or even cease, although at this stage it’s very difficult to state when the political approach will allow for an increase.” CU’s own overseas exposure was marginal last year because of the difficulties in managing such small limits, because the Polish capital markets themselves have performed strongly and because there is some exposure through foreign stocks listed on the Warsaw Stock Exchange, which count as local equity.
Czech funds are among the most heavily weighted in bonds, which accounted for 81% of the total portfolio at the end of 2004. Shares, at just under 6% of the total, were marginally up on the 4.8% a year earlier. There was some variation: Allianz’s fund had no equity component at the end of 2004 while CSOB’s two funds had around 11% each.
“Under Czech law pension funds have to provide positive returns each year, so all managers are cautious in their orientation,” explains Jiri Rusnok, executive adviser to the management committee of ING’s Czech and Slovak pensions, and president of the Association of Czech Pension Funds. Rusnok adds that even though Czech laws are liberal, around 95% of assets are invested domestically, although there has been some recent appetite for investment elsewhere in the region.
Similarly Slovakia’s five voluntary funds – and since the beginning of 2005 its new mandatory funds – have focused on bonds, although in Slovakia this has also been conditioned by the small and illiquid equity market.
Hungarian mandatory pensions have also been focused on bonds, despite the strong performance of the Budapest Stock Exchange where prices increased by close to 60%. The average portfolio at the end of 2004 held 74% in government bonds, 2% in corporate bonds, 8% in shares and 9% in investment units. Compared with 2003 fund managers increased their weighting in government bonds and investment units by four percentage points and two percentage points, respectively, at the expense of other assets.
There were some individual differences. OTP, the largest Hungarian fund, registered an asset growth of 56% in forint terms while its membership was up by 5.5%, largely as a result of enrolling young members entering the labour market. OTP, the only sizeable financial institution in the region not owned by foreign investors, is also the default fund for workers who cannot decide among the 18 mandatory funds on offer.
Its portfolio had a lower-than-average government bond weighting (57%) and in equities (6%), but a relatively high percentage in investment funds (19%) and mortgages (13%). For 2005 its benchmark portfolio will include a minimum of 65% and a maximum 95% long-term state securities, 15% short-term state securities, 3% Hungarian equities, 7% central European equities and 10% shares of mature markets.
Polish pension funds, in contrast, are exceptionally heavily weighted in equities, which accounted for around one-third of the average portfolio. According to CU’s Szczepiorkowski, the high equity exposure represents part of the convergence trend and also offers exposure to the economy. In addition, it enabled the funds to produce better returns than would have been the case had they been as heavily weighted in bonds as Hungarian and Czech funds. The return on CU’s fund in 2004, for instance, was 13.4%, compared with 27.9% for the blue chip Polish equity WIG 20 index and 8.81% for government bonds.
Jaroslaw Jamka, chief investment officer and vice-president of the ING Nationale-Nederlanden management board, Poland’s pension management company, explains that the top three funds have similar equity strategies, focusing on the blue chips, while the smaller funds have been more heavily invested in mid and small caps. Last year the ING fund also had some real estate exposure via investment certificates in closed end mutual funds (around 0.4% of the portfolio) as well as two real estate companies quoted on the Warsaw Stock Exchange.
Jamka notes that the large stakes of Polish pension funds in the local equity market resulted in higher liquidity risk but also improved corporate governance: “The distinguishing feature of the Polish market is that fund managers can increase shareholder value through corporate governance.” From 2006 pension funds will have to publish their voting records on companies and the industry is now working on best-practice codes for fund managers, including asset management rules.
The heaviest equity exposure is found in the Baltic progressive funds. These are also more popular in the region than bond funds as they currently provide higher yields. The largest in Estonia, Latvia and Lithuania are run by Hansabank, which uses a single asset management matrix for its eight funds in all three countries, and which in the last 15 months has focused heavily on the growth markets of central and eastern Europe.
“We moved into the central and eastern Europe accession countries in spring 2004 and there have been no significant changes for 2005,” explains Alvar Roosimaa, east European equity fund manager at Hansa Investment Funds in Tallinn. Some 25% of Hansa’s K3 growth fund is in central and eastern Europe and 8% in Baltic equity.
For fund managers like Roosimaa the short-term challenges are to manage the huge interest rate and stock price volatilities in the region, including the recent rally in markets such as Hungary and Bulgaria. In the medium term many countries still need to address legal inconsistencies and shortfalls.
The legal opinion of most countries running mandatory systems and non-occupational voluntary schemes is that these do not fall within the EU pensions directive. The directive includes legal separation of the pension fund and its management company, which is currently not the case in the Czech Republic and Hungary, and until recently Slovakia.
One of the big challenges facing Polish funds is that they need to prepare for paying out the first annuities in 2009. Currently there is no annuities legislation covering the second pillar funds, and further, the pension fund companies can only manage one fund covering all age groups. CU’s Szczepiorkowski believes that these issues will be addressed after the general election this autumn. “It will have an impact on the investment strategies appropriate for the oldest members,” he says. “The discussion should focus on how to arrange any transfer, should it be obligatory and, if not, how to arrange for members to be aware that such possibilities exist.”
Expenses are another continuing headache across the region. “Czech funds are costly; 100-200 basis points on such administrative costs as back offices, postage, asset management and custodial fees, and on staffing, which have to be deducted from the final portfolio performance,” notes Rusnok.
The products are essentially similar, so providers compete for new members using extensive and ultimately expensive sales networks in a market where 50% of the workforce already has a voluntary pension. By contrast, under Polish legislation, all transaction, custodial and tax-related expenses such as stamp duties must be borne by the fund manager and not passed onto the client.
Market forces are playing a role here. In the countries with large numbers of funds, consolidation has been inevitable. The number of funds in the Czech market has shrunk to 11 from more than 40. In Poland the number is down to 15 from 21, but the most recent regulatory changes have not favoured pension mergers, and despite a reported number of willing sellers, buyers remain more cautious.
In those countries with smaller numbers of players, many fund managers face an uphill battle against competitors who achieved market dominance early on. In the Baltic region Hansa Investment has some 50% of the market while in Slovakia Tatry-Sympatia’s voluntary fund, which was recently acquired by ING, has a 47% market share.
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