Taking the slow road to reform
The development of the Italian pension fund industry has slowed down. Political discussions regarding the reform of the system, changes in the labour market and the never-ending negotiations about the transfer of the TFR into pensions, have increased uncertainty about the future growth of the industry.
According to a recent report released by Milan-based IAMA Consulting, only 6.6% of Italian workers have signed up to one of the new complementary pension funds. This figure falls way below the 20% forecast at the time of the Dini pension reforms in 1995. IAMA notes that even taking into account the number of people covered under the existing pension funds, the percentage is still only 10% of total workers, representing just under 2m people.
The complementary pension funds were introduced in Italy only in 1999 as a way to boost the underdeveloped second and third pillar systems in the country. So far, 41 new second pillar closed-end pension funds have been created. Although this number may sound quite significant, both the small size in terms of assets of these funds and the low participation registered in most of them are disappointing for politicians, social partners and the asset management industry as a whole.
According to data from Mefop – a government-sponsored organisation created to monitor and assist the development of the pension fund industry – at the end of 2001 the total assets of the new closed-end funds amounted to only e2.2bn, covering a total of 1m workers. The total assets for the third pillar individual pensions represented around e950m with just below 300,000 affiliates.
Prime minister Silvio Berlusconi, who a year ago declared he would quit if he didn’t create 1.5m jobs, cut taxes, reduce bureaucracy and reform pensions, has so far disappointed those who expected to see substantial improvements during his first 12 months in power.
For some, the situation of the pension fund industry is even worse than 12 months ago, and recent proposals regarding the reform of the labour market has been translated into tension among Italians. In a country were unemployment benefits practically do not exist, proposals regarding the liberalisation of the labour market making easier for employees to terminate contracts resulted in demonstrations across Italy’s major cities.
Obviously, the question about the transfer of the TFR – a lump sum that workers receive when leaving a company – into pension funds is now more delicate than ever, but probably the only solution to inject real money in the newly created market.
“The situation today is more uncertain than it was a year ago,” says Piero Marchettini, managing partner at Adelaide Consulting in Milan. “At that time there was a lot of expectation regarding the new government and its commitment to boost the second pillar, but now we see that this hasn’t happened. The transfer of the TFR does not only depend on issuing a specific law, but this has to be also acceptable by employers and employees.”
On the employers’ side, this transfer has never been welcome since these huge amounts of money in their book reserves have been as a way of self-financing. For this transfer to be acceptable companies want something in exchange, like the reduction in contributions to social security that is now under discussion. On the other side, employees do not want to lose the guaranteed income that the TFR means at a time when job security is under threat.
This situation is clearly affecting asset managers in Italy, who have been waiting for some time to see the industry really taking off. The TFR is not only stopping growth in terms of assets but also used as a benchmark to compare performance. During the past couple of years returns on the TFR have been higher than the average pension fund performance and asset managers have sometimes found it very difficult to live with this.
“At the moment our performances are compared with two benchmarks, and sometimes this is quite difficult,” says Marco Barbaro, managing director at BNP Paribas Asset Management in Milan. “We have the real benchmark given by the asset allocation of the portfolios and the TFR. So there is always tension between the short term and the medium-long term investment objectives.” BNP Paribas currently manages around e1.4bn for Italian institutional clients.
Barbaro comments how closed-end pension funds are still conservative in terms of investments. “In theory, pension funds should be looking at the long-term liabilities and following quite an aggressive approach to investment, but in Italy, where the average exposure to equities is around 25% of total assets, this is certainly not the case.” Under the pressure of the TFR returns and coming from a strong bond culture, the new closed-end funds have found investing in fixed income a safe way to guarantee positive returns during their first few years of activity.
In the months to come some mandates coming from closed-end pension funds that still haven’t finalised the manager selection process will be awarded (see table on page 26). Even though the size of these mandates is very small, being appointed at this moment is for both local and foreign asset managers a way to establish themselves as recognised players in a market with huge potential for business growth.
Consequently, competition among managers is getting tougher and tougher. The strong presence in the market of the big Italian financial institutions and a fee structure that some describe as very low, makes it very difficult for foreigners to grow in this market.
“Fees are an important factor that clients take into account when choosing managers,” says Matteo Astolfi, manager for institutional clients at Pioneer Investment Management in Milan. “The market is growing and there is strong competition among managers to gain market share, and low fees sometimes attract clients’ interest. However, you get what you pay for and in the near future we will see clients changing managers that were selected taking into account their low fees, because pension funds are becoming more focused on quality.”
Local houses know that big international names already present in the retail market have a very good chance to grow in the institutional arena. “We see more international houses winning mandates for the closed-end pension funds. This is a natural development of the industry and Italian investors are prepared to choose a foreigner if it proves to be better. Those who prove to be good have a good chance in the market whether they are Italian or not. This is all about quality and good service,” says Simone Facchinato, manager at the institutional clients division at Arca SGR in Milan. Arca manages e7.5bn for Italian institutional clients. “The market is small now but those who want to succeed here have to get ready now. We have a very good position in all the segments of the market and a very strong brand name. But competitors will always be there and this is good for the development of the industry.”
At BNP Paribas, Barbaro comments: “Competition has grown a lot in the past couple of years, and fees have been paying an important role.” He continues: “The opening of this market have attracted all the important asset managers from all over the world and everyone is being very aggressive in order to expand their business here. On the other hand local asset management companies, which are really controlled by the big banking institutions in Italy, are fighting back to maintain their share in this industry. However, I won’t be surprise if the fee level tends to go up in the near future.”
This opinion is shared by Fabrizio Gualco, director at Credit Suisse Asset Management in Milan. “I think prices are recovering from a low base as clients are now more focused on quality than on costs. Some clients still find it difficult to see that managers that have more resources and employ more experts are more expensive, and tend to see asset management as a standarised product. This concept is slowly changing and more and more investors are prepared to pay higher fees for a better service.”
The fact that investors are prepared to pay more also brings opportunities for consultants operating in the market. “I think we will see the market becoming much more selective and consultants playing a more important role with local consultancy firms attracting more interest from clients,” says Barbaro.
At ING Investment Management in Milan, head of institutional clients Carlo Benetti comments: “The increasing presence of consultants in the market is a good thing. They speak our language and they translate it for investors. Local consultants with a good knowledge of the market are playing a very important role in manager selection.” ING manages around e700m for institutional clients in Italy.
The use of consultants is also becoming more popular in another segment of significant the institutional business, the banking foundations. While asset managers wait for the development of the closed-end pension funds, foundations have kept them busy and some are focusing on this area of the market more than any other. A few years ago Italian banking foundations were basically forced to sell the shares they had in the banks over a number of years. This liquidity is now being reinvested. At present there are around 100 banking foundations in the market, although obtaining figures regarding assets under management and the investment strategies they follow is an almost impossible task.
“In terms of assets the top five foundations in Italy represent around 70% of the total market,” says BNP Paribas’ Barbaro. “So the size of most of these institutions is quite small. The large ones make their own asset allocation and pick specialist asset managers. On the other hand the small and medium-sized ones go for balanced mandates.”
For these institutions having liquidity is something new and many are using consultants when it comes to asset allocation and manager selection.
“Although banking foundations are interested in the whole range of investment products, from our experience they are still very focused on fixed income strategies,” says Marcel de Bruijckere, responsible for institutional clients at Antonveneta ABN Amro in Milan. The company manages around e1bn for Italian institutional investors.“At present they are mainly hiring bond managers and the next step will be focusing on equities, but this is a slow process. However we expect that some of those who have already taken care of the fixed income part of their portfolios will now come to the market looking for equities.”
However, the specific characteristics of the foundations mean that a substantial increase in their equity exposure is quite unlikely. “Foundations are organisations that basically need to get a positive return every year in order to finance their various activities,” says CSAM’s Gualco. “Ideally their expected returns would be between 5–6%, so they are more short-term oriented than pension funds.”
In addition to foundations, the old pension funds, those that already existed before the introduction of the new schemes, are also an important target for managers. “Most of them are run by ex-public companies and multinationals and have been operating for years,” says Pioneer’s Astolfi. In terms of assets, this market is much bigger than the new pension funds, although no figures are available. “The market for old pension funds is very diversified because every fund has its own investment rules. In this area there is already some demand for alternative asset classes, and some funds are already investing in hedge funds because regulation is more flexible.”
Apart from this exposure to hedge funds in some of the old pension funds, alternative products haven’t really penetrated the Italian institutional market. “In the high net worth individual market we see more demand for alternative investments but, so far, institutions are investing moderately in these products,” says Gualco. “There is a lot of talking but activity is still low.”
Alternatives are still considered as a risky option, and investors want to keep away from risk at the moment.
The recent downturn in the equity markets has also increased the interest among investors in everything related to risk management. As the level of sophistication among clients increases, the demand for more transparency and greater risk control is a fact. Investors are now willing to pay more to control risk and asset managers know they have to expand their risk management capabilities.
“Pension fund boards in Italy are paying more attention to risk management instead of only concentrate on performance,” says ING’s Benetti. “This is not only a consequence of 11 September but also after the Unilever–Merrill Lynch case that brought home the importance of controlling the active risk in their portfolios.” He adds: “This is a sign that the market is moving from childhood to adulthood. IIM has a sound risk management team and is investing resources and efforts in improving its risk management capabilities.”
At a time when performance is clearly not the only thing that investors are looking at, interest in sustainable investment is also on the agenda. In the retail market, socially responsible investment (SRI) funds have been very popular in Italy during the past few years, but institutions had shown little interest in this investment approach. However, the creation of new pension funds where unions are playing a major role, and the interest in this area shown by some banking foundations is giving SRI a chance to develop within the institutional business. “The boards of directors are talking about these issues more and more and there is an increasing attention to the different SRI products in offer at the moment,” says ING’s Benetti. “Our SRI products have a good track record so we are ready to enter this game.”
The recovery in the equity markets and the expectation about political decisions regarding the future of this industry will keep asset managers and plan sponsors busy in the months to come. However in terms of business growth the outlook is not very positive. “We won’t see more closed-end funds being created in the near future, and the assets of those that have already been authorised won’t grow with the transfer of the TFR,” says Adelaide’s Marchettini. “In Italy it is very difficult to get any consensus when it comes to big changes and this is one of those cases. It would be very difficult to convince employees to exchange the TFR’s expendable income into a deferred compensation, if you don’t give them unemployment benefits. On the other hand, it would be also difficult to convince employers to get rid of the TFR if you don’t reduce their contributions to social security.”
He adds: “Things will not be easy for asset managers because the market is not developing at the right pace. The level of fees is low and as long as the market doesn’t grow increasing fees will be difficult.”
The months ahead will be also difficult for the government. A package of reforms that has already been approved by parliament have now been stopped by the executive under pressures from unions and employer associations. Were it passed, the package, which includes changes in contribution rates, more flexibility for asset managers and amendments to the retirement age, could, according to estimates from IAMA Consulting, help increasing the size of the pension fund industry as a whole from e3.6bn to e39.5bn by 2005.
If this and other reforms including the transfer of the TFR take place in the near future, the potential for business growth for all the players present in the market will be huge. If they don’t it, will be back to square one.