Struggling to diversify
Assets, or rather the lack of them, are a big headache for local fund managers. The local equity markets are small and the number of truly liquid shares tiny: the large banks, the three former state-owned telecommunications companies and a handful of industrials. In the short term the situation is set to get worse. By November Skandinaviska Enskilda Banken (SEB) of Sweden had nearly completed the full takeover of three major banks in the Baltics, Estonia’s Uhispank, Lithuania’s Vilniaus Banka and Latvia’s Unibanka, and is in the process of delisting its subsidiaries. Sampo-Leonia, the Finnish banking and insurance group, has also applied to delist the shares of Optiva Bank, Estonia’s third largest.
For Latvia’s putative pension managers the ceiling rules on asset management restrict equity investment to 10%, and to the official or first tier list of the Riga Stock Exchange. Initiatives designed to inject life into Baltic equities such as a pan-Baltic blue chip list and plans to join the Norex Nordic alliance are thus academic. The funds also cannot buy corporate debt. The biggest headache is the 15% restriction on overseas investment. This was not an oversight, as the Latvian authorities fully intended to get the funds first and foremost to invest in the local economy, but the asset managers themselves have little opportunity for diversification, provision of schemes with different risk profiles or differentiation from their competitors. The law assumes otherwise as each fund is expected to have a pre-defined risk profile which then determines asset allocation.
The industry, via the private pensions funds committee, is lobbying intensely for a compromise on diversification, arguing that the long-term benefits of private pensioners should also be taken into account. “We want to be able to offer better diversified investments, with conservative funds for those with low risk tolerance and a well diversified higher-risk product for younger investors,” stresses Indra Samite, vice president at Unipensija, the pension fund run by Unibanka. Sergej Medvedev, head of investment products at Parex Bank, adds that given Latvia’s drive to join the EU, stock investment should be extended to include EU member state shares as well as those of top tier OECD countries, Estonia and Lithuania. “There are also some stock in Latvia not currently quoted on the Riga Stock Exchange official list but of good credit quality, such as Swedish Export Credit and Merita Bank, as well as some shares on the exchange’s second tier that we would like to be able to buy.”
Inevitably pension fund investment has been channelled into government treasuries, which as of this year extended to five years. Pension funds can also invest up to 10% in mortgage bonds issued by the government-backed Latvijas Hipoteku un Zemes banka, a two-year lats bond issued by Nordic Investment Bank and quoted on the Riga Stock Exchange as well as bank deposits. Unipensija, for example, is 75% invested in treasuries, bank deposits and mortgage bonds, with the remainder in cash and stocks.
With the law funnelling pension funds into the state security market, there is a potential conflict of interest which intensifies as Latvia’s second pillar scheme comes into operation, probably by mid 2001. For a two-year period, until it reaches a respectable size, the second pillar fund will be managed by the state treasury. “Basically, the same state institution will be issuing bonds with the right hand and buying with the left,” notes Parex’s Medvedev.
In Estonia the investment rules for private pension funds are less restrictive, with a 40% cap on equities and no limit on overseas investments as long as they fall within certain credit criteria such as OECD membership. The Estonian fixed income market includes commercial paper, kroon-denominated paper from institutions such as Swedish Export Credit and Nordic Investment Bank, and bonds issued by the big banks, but crucially there is no Estonian government debt as the government is not allowed to set budgets with deficits. Consequently both the equity and foreign investment limits had to be generous from the start, and investment criteria for the second pillar funds are expected to be similar, predicts Loit Linnupold, CEO of Uhispank Asset Management: “The 40% equity limit will be applied to second pillar funds, and the third pillar can be set free in a couple of years’ time.”
Lithuania’s pensions laws are still being drafted and investment criteria have still to be established. Unlike Estonia there is a government debt market out to five years, public corporate bonds issued by Lithuanian Energy, the state electricity company, and by Lithuanian Telekoms, Lithuanian sovereign Eurobonds which can be purchased on a private basis and litas-denominated bonds from Swedish Export Credit. The government does borrow extensively, however, and with the need to finance the reform of the state social security system, is likely to keep its new pensions companies investing as much at home as it can in the initial phase.