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Impact Investing

IPE special report May 2018

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The Mediterranean: Widening the spectrum

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Cypriot pension funds are slowly diversifying away from cash and local markets, writes Roxanne McMeeken

Social security in Cyprus has traditionally been blighted with the widespread - and for many, eyebrow-raising - tendency to keep entire pension fund portfolios in cash. But in January 2010, rules were introduced aimed at encouraging the country's retirement funds towards a more professional approach. A year later, investment management is improving thanks to the legislation and other factors, but the system retains some alarming flaws. One Cypriot pension fund, however, the €266m Hotel Employees Provident Fund (HEPF), is setting a pioneering example, which offers hope that others will follow.

Considering Cyprus is an island, has a population of just 767,000 and some 2,000 pension funds, it is unsurprising it was not at as highly developed as some other countries in the area of investment management. But the new pension scheme rules, regulations 1/2010 and 2/2010, which came into force on 22 January 2010, are helping the modernisation. They say schemes must take professional advice and follow certain guidelines on investment processes and ranges of assets, including a maximum exposure to real estate of 40% and to equities and corporate bonds combined of 70%.

The first healthy step trustees were required to take was to submit a statement of investment policy to the regulator for approval. Anastasia Anastassiades, senior consultant and actuary at Aon Hewitt in Nicosia, says: "We understand that all the funds covered by the regulations have done this, although not all have gained approval yet, but the process has meant many funds are now looking at equities and bonds as alternatives to cash - albeit conservatively."

This is more radical than it initially sounds given that the vast majority of the pension funds in Cyprus, with an estimated €3.5-4bn in total assets under management, were held in cash or fixed deposit bank accounts. The approach is understandable too, considering generous interest rates of around 7% in recent years from local bank deposit accounts. These are expiring now, though, and rates are down to an average of 4.1%, which is also spurring pension funds to change their investment strategies.

In terms of asset allocation, Demetris Taxitaris, head of fund management at CISCO, part of the Bank of Cyprus Group, says the typical new-look pension portfolios have 10-30% in equities, 10-40% in bonds with the remainder in cash.

Going global
Further evolution is underway and schemes are moving towards a more international mix within equity and bond portfolios: "It was 50% foreign at first but now domestic allocations are falling," Taxitaris says.

This is due to a combination of the global banking crisis, the downturn in Greece and the sovereign problems of the euro-zone. The Cypriot economy is largely dependent on the banking industry and has traditionally had strong links to Greece with about 80% of its public companies being listed both at home and in Athens.

Taxitaris says: "We are seeing diversification in terms of industry and geographical region in both equities and bonds as investment committees consider how best to insulate their exposure to Greece - which the majority have." Some pension funds are appointing foreign fund managers as part of this process, although Taxitaris says there is a "slight preference for locally-based firms".

Where Cypriot funds invest in global equities, they are looking for a considerable return premium for this foray into unchartered territory. Anastassiades says international portfolios tend to be actively managed and the average target return is the MSCI World index plus three points.

Could alternative investments follow? Anastassiades's firm Aon Hewitt is trying to promote these asset classes in various ways, including at a forthcoming seminar on property and hedge funds, but she laughs at the idea that their might be a rush for alternatives. "Many pension funds are still struggling to comprehend the idea deposits will not continue to deliver what they used to, so hedge funds are hardly on their radars."

However, hotel sector scheme, the Hotel Employees Provident Fund (HEPF), which she says is "a couple of steps ahead of everyone else", is considering alternatives - a move which could encourage other schemes to follow suit. Marinos Gialeli is general manager of the scheme, which has won IPE awards for Best Pension Fund in Small Countries two years in a row, as well as the Best Small European Pension Fund Award in 2010. He says: "We are discussing with our trustees and consultants the possibility of a 5% allocation to hedge funds." HEPF is currently invested 12% in equities (all international) 28% in bonds (including a 5.3% allocation to global bonds), 8.5% in local property, with the rest in cash.

Unfortunately, few Cypriot pension funds are as fast moving as HEPF. Anastassiades says: "For Cyprus, it's actually quite early to assess the impact of the new legislation as trustees of many pension funds meet only about once every three months - and just for an hour. So with four or five hours worth of meetings they are unlikely to be able to appoint a range of global equity managers."

Further obstacles to progress lie in the regulations themselves. For example, they do not apply to pension funds covering fewer than 100 employees, which amounts to about 20% of defined contribution scheme members. Anastassiades says Aon Hewitt wants to see everyone covered but the reason they are not is understandable: "A firm with only 30 employees cannot afford to appoint asset managers and consultants - it could even lead to financial losses."

How can members of such schemes be better catered for? The consolidation that could address the problem seems some way off but there is a glimmer of hope at least: Gialeli is lobbying for it. He says: "We are trying to convince the authorities and trade unions that having so many small pension funds is not delivering much value." He is also in discussions with the regulator on the possibility of opening up HEPF to employees outside the hotel sector: "The authorities are sceptical, but we are trying to explain that we need scale in order to grow."

Unsolved problems
Another bugbear for Gialeli is one the most worrying aspects of Cypriot system, which last year's legislation failed to address. This is that members are free to withdraw their assets from their pension fund if they switch to work in another industry. Gialeli says this leads to HEPF, which manages assets of €266m, losing an average €20m annually. "Imagine if we didn't have that outflow - we would soon be at €1bn."

Equally harmful, is that members are allowed to borrow from their pension fund, with the security being their retirement provision. Anastassiades states on this and early withdrawals: "We want to see the law changed, the present system is causing huge damage and could lead to poverty in Cyprus within a generation."

Other issues that last year's legislation failed to resolve include low retirement ages - many workers have the option to retire at 63, while civil servants are entitled to retire at 60.

A final problem is that some funds are ignoring the new regulations altogether, Anastassiades says. "Once the legislation came out everyone was left to interpret it, with little guidance, and you would not believe how many funds believe they do not apply to them."

More supervision and guidance from the regulator is needed urgently, she says. "We are moving in the right direction but not fast enough, and further reforms are required."
 

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