Two-way traffic ahead
Asset management in the EU’s central and east European members states remains dominated by the second pillar pensions system that most of the countries have adopted. While some of the pension funds rank among the top 1,000 in Europe, the investment fund industry is still small.
According to data from , the European Federation of Investment Funds and Companies (Fefsi), as of the end of June 2004 the Czech Republic, Hungary, Poland and Slovakia had a combined market share of only 0.3% of the €5,158bn of net assets in UCITS and other nationally regulated funds.
Compared with June 2003, when assets of the 23 members grew by 7.1%, the Czech Republic had a below average growth rate of 5.5%, while Hungary’s total assets fell by 1.5%. Poland, with the largest of the CEE markets, was up by 9.3%, while in Slovakia, the smallest of the CEE Fefsi members, investment assets soared by 32%. However, in the second quarter of the year the CEE countries were among the few to buck the trend and increase assets under management while most of the rest of the European funds industry was suffering from a fall in confidence over the impact of soaring oil prices on the world economy and declines in west European stock prices.
For the CEE asset management industry, EU accession in May primarily meant a rapid harmonisation of the relevant legislation, not all of it well received. The new Polish investment act is considered by the market to have a number of deficiencies. Likewise the Czech act on collective investments that came into force in 2004 is not ideal, according to Josef Benes, CEO of CSOB Asset Management, the largest Czech investment fund manager, and awaits further refinement. One of the act’s achievements however was to distinguish between regular investment funds and ‘special funds’ such as hedge funds and those dealing with real estate.
In Latvia, on the other hand, harmonisation rationalised previous regulatory requirements by allowing investment companies to manage discretionary portfolios, previously restricted to brokerages. Another legal change, expected next year, would allow the euro to be classed as a matching currency alongside the lats: currently Latvian pension funds can invest a maximum 30% in non-matching currencies.
For financial houses from the EU- 15, the cost of doing business in the new members states falls as they no longer need to set up a physical presence.
Given that most of the main operators in the new member states are already foreign owned - for instance, 17 of the 18 investment houses in the case of Poland - the landscape will not change that significantly.
However, Benes warns that the local investment houses can expect competition in private banking and consequent pressure on fees.
In the longer term the asset management industry has to benefit if membership delivers the promise to increase wealth. According to a study published by Pioneer Pekao, the largest Polish investment manager, and its Italian parent Unicredito, personal wealth in the “new” Europe (including Bulgaria, Croatia, Romania and Turkey but excluding Slovenia), personal per head was only e3,998 in 2003, compared with e24,174 in the EU-15. The study forecasts, nevertheless, that household wealth will rise considerably, with more money being channelled into private pensions, stocks and mutual funds, rather than being hoarded as cash or kept on deposit. By the end of 2007, the study predicts investments into mutual funds will have risen by 29%, pension fund assets by 27% and securities by 17%, compared with only 8% for bank deposits.
However, a number of the new EU members had had major domestic political problems. In Poland the embattled prime minister Leszek Miller resigned a day after EU accession, while his successor Marek Belka faces continuing problems of leading a government without a parliamentary majority. In July the Czech prime minister Vladimir Spidla was replaced by his deputy Stanislav Gross. In August Hungary’s premier was forced to resign, while the following month the Latvian government collapsed. In October the ruling Liberal Democracy of Slovenia was swept out of power in October’s general election, to be replaced by a centre-right coalition.
The changes have generally been beneficial for the investment industry.
In the case of Poland, both the bond and equity markets benefited. “The former prime minister and government had low credibility, which adversely affected the rating of Polish debt, and was a problem for the fixed income market,” notes Zbigniew Jagiello, president of Pioneer Pekao TFI, Poland’s largest investment fund company with around a third of total assets under management. The new administration also benefited the equity market. The new treasury minister, Jacek Socha, former head of the Polish Securities Commission, is an enthusiastic advocate of privatisation and accelerated the sale of PKO BP, Poland’s biggest retail bank, whose November flotation pushed the Warsaw stock exchange to record levels. The exchange has also had a record number of IPOs in 2004.
Poland’s second pillar pension funds are major players on the Warsaw Stock Exchange, the region’s largest bourse by market capitalisation, while the pensions system itself is also the largest. Assets as of the end of September grew by 37% year on year in Polish zloty terms to total PLN55.7bn (€12.7bn). Of these, bonds accounted for 61% of assets and equities 32%. While the second pillar and investment funds are managed by separate companies, a new pensions product, the individual retirement account launched in September 2004, can be offered by a range of providers, such as banks, brokerages, investment and insurance companies.
The Polish investment fund industry grew to PLN35bn of assets under management in October 2004, from PLN33bn a year earlier. The structure by share of asset class has changed markedly since 2003, when the bond market was hit by poor economic data and contamination from the massive bond sell-off in Hungary.
As of October 2004, balanced funds accounted for 22% against 7% 12 months earlier, pushing bond funds into second place with 21% (against 48% a year earlier), followed by money market funds at 17% (unchanged from 2003), and stable growth funds (a type of voluntary pension product), equity and foreign bonds at 12%. In 2003 the respective market shares of the last three were 12%, 6% and 8% respectively.
Equity funds have been this year’s best performers, with returns of 15-20% against 8-10% for balanced funds and 4-6% for fixed income, reflecting a high confidence in the Warsaw stock exchange.
Jagiello cautions that Polish stocks are now overvalued, and prices set to become more volatile in the near future, and that clients should be shifting into safer fixed income and money market funds.
Meanwhile fixed and money market funds have since June suffered the inevitable competition from bank deposits as a result of three interest rate hikes, totalling 125 basis points, because of inflation fears. Jagiello nevertheless forecasts that the second half of 2005 should be a good year for fixed income funds.
In Hungary fund performance was less volatile than in 2003. The total size of assets under management as of the end of May 2004 was 2.144bn Hungarian forints (€8,252.5bn), including €2,087.4bn in the mandatory pensions sector, €1,095.2bn in the voluntary pensions sector, €1,942bn in segregated portfolios and €3,354.9bn in investment funds, according to data from, the Association of Investment Fund Management Companies in Hungary (BAMOSZ). Since the beginning of the year the mandatory and voluntary pensions sectors has grown by 16% in forint terms, and segregated portfolios by 22%.
The investment fund market has contracted by 27% year on year and by 7% since the start of the year, largely because of an outflow of money from bond funds, following last year’s interest rate rises. Domestic bond funds still account for the largest proportion of investment funds, 48% as of end May 2004, but this is significantly down on the 66% share 12 months’ earlier.
Money market funds are the second biggest class at 25%, followed by international securities (11%), property (8%), equity (7%) and balanced funds at 1%. Since May 2003, bond fund assets had fallen by 47% and those of balanced funds by 46%, and those of money markets by 14%. The big gainers were international funds up 77%, equity up 56% and property up 44%. Equity investors nevertheless favoured the international market - international equity funds totalled HUF 60.2bn against HUF 55.3bn in domestic equity funds - which with hindsight was not the best decision, as the Hungarian stock market was one of the world’s best performers in 2004.
In the Czech market, the two main branches of asset management are private pensions and investment funds. The private pensions market as measured by participants’ funds, totalled CKr89.101bn (€2.8bn) as of the third quarter of 2004, a year on year rise of 22% in Czech crown terms.
There is no second pillar as yet, but an all-party parliamentary group is currently examining a comprehensive reform of the pensions system.
The investment fund industry is one of the longest established, with a long history of distributing foreign funds. Assets under management by members of the Union of Investment Companies of the Czech Republic (UNIS), fell to CKr108.83bn (€3.4bn) as of the end of June 2004, from a historical high of CKr114.38bn 12 months’ earlier, (primarily because of tax changes).
The big event for the market has been the Prague stock exchange’s first IPO, of the pharmaceutical company Zentiva, which floated in June, along a record turnover on the exchange. “It created a very positive attitude towards the exchange, following on from a good year for Czech blue chips,” notes CSOB’s Benes. Equity funds based on Prague-listed stocks have produced returns of 11-12% compared with 4% for bond funds and slightly less for money markets. Those mixed funds with a high proportion of central European assets have also produced good returns, of 10-20%.
However, Czech investment fund holders remained focused on money market funds, which accounted for a hefty 51% of all investment fund assets as of mid-2004, a share unchanged from 12 months ago. The share of bond funds declined to 21% from 27% a year earlier, while the equity portion, although up from 2 to 4%, remains tiny. In such a risk-averse environment, CSOB three years ago launched capital guarantee funds.
Although they provide interest income - the principal is guaranteed - the underlying assets are worldwide equities. Benes describes these as an introduction to equities for traditionally risk-averse investors.
In neighbouring Slovakia the investment fund industry totals around SKr54.6bn (€1.4bn) according to data from Slovakia’s Association of Asset Management Companies.
Again money market funds dominate, accounting for 56% of total net asset value - declining interest rates and a strengthening currency have been important determinants here - followed by bonds at 36%. “Their performance has been good in absolute terms, and also compared to international markets,” notes Martin Duriancik, portfolio manager of Tatra Asset Management. Balanced and equity funds account for a small 5% and 3% respectively. “The core of the business is still conservative,” he adds.
Like the Czech Republic, Slovakia has a long established private pensions industry; unlike its neighbour, it has opted for a mandatory second pillar system, which starts operating at the start of 2005.
In addition to a largely voluntary pensions market - mandatory funded pensions only apply to selected professions - Slovenia has a rapidly growing fund market, totalling some 187.1bn Slovenian tolars (€780.2m) as of mid November. The number of fund holders has rocketed, to nearly 88,000 as of November, from 58,781 at the end of 2003 and 37,965 a year earlier. Balanced funds are by far the most popular, accounting for 69% by assets, followed by equity at 27% and bonds at a mere 4%. The biggest are Galileo (mixed) and Rastko (equity), both managed by KD-Investments, Slovenia’s largest investment manager in terms of market share.
Slovenians have a high savings rate by regional standards, but one of the lowest investments rates in the EU for mutual funds. Although the Slovenian market has been to-date a local industry, foreign fund managers are set to present a challenge. In August Raiffeisen Krekova Bank, the Slovenian subsidiary of the Austrian group, became the first bank to receive a licence for marketing foreign funds in Slovenia.
The Slovenian investment funds industry has undergone some of the most profound legislative changes. The 50-odd privatisation funds that were established from 1994 onwards as an investment vehicle for privatisation vouchers, and which never succeeded in accumulating sufficient assets, were eventually obliged by legal changes in 1999 to transform into mutual funds, joint stock companies or investment companies. By the end of 2003 all had converted, mostly into investment companies, and in a number of cases into several new entities.
In the Baltic states, money market funds are, as in the Czech Republic, highly popular, although for banks cross-marketing, they present a challenge of fee income versus interest earnings, as they inevitably erode the deposit base that funds loans. Pensions account for the largest portion of assets under management. In Latvia, the state-funded scheme had 564,169 members and net assets of Lats35.3m (€53.2m) as of the end of June 2004, the private system 33,140 members and assets of Lats23.4m, according to data from Latvia’s Financial and Capital Market Commission, the regulator for the pensions, securities and investment fund industries.
The investment fund industry as of the third quarter of 2004 consisted of 17 funds, of which 12 are open, managed by nine companies. Net assets totalled Lats31.2m (€46.5m), a year on year rise in Lats terms of 43%. By sector, government and corporate debt securities (including money market funds) accounted for 44% and 43% respectively, and equity 12% (compared with 5% a year earlier).
Hansabankas’s money market fund, the oldest investment fund, accounts for around half the market in terms of assets.
“The absolute figures are small but the growth rates are very good,” notes Sergey Medvedev, president of Parex Investment Company. “Our funds grew by 217% in the first nine months of the year.” The company manages seven funds, including the largest closed-end fund (investing in real estate). Unlike the heavily retail oriented markets elsewhere in central Europe, Latvian investment funds have a broader range of customers.
“Corporate clients invest in money market funds for liquidity management as interest rates are falling, insurance companies in equity and balanced funds, while pension funds use our funds to gain exposure to different asset classes,” explains Medvedev.
As of mid 2004 investment funds accounted for 3% of state-funded pension fund investment portfolios and a sizeable 11% in the case of private ones. Parex also offers two US dollar-denominated funds, one invested exclusively in Russian equity (which is priced in dollars), the other in east European bonds, including a sizeable proportion of Russian bonds, also priced in dollars. “There are still many Latvian clients investing in dollars, but the dollar bond fund is losing ground to our Euro-denominated bond fund,” Medvedev adds.
Estonia has the largest state pensions system, EEK2bn (€130m) as of the end of the third quarter of 2004,which has grown rapidly since its launch in January 2002, despite being only compulsory for the new labour market entrants, and requiring additional contributions from participants salaries in addition to the usual diversion of a portion of the state pension fund contribution. The much smaller third pillar system had some EEK139m in pension funds, in addition to pension-insurance type products.
According to Mikhel Oim, head of Hansa Asset Management, growth in the second pillar system will probably level off as only 15-20% of those eligible to sign up have not done so. Hansabank itself has 50% market share of the assets under management in the second pillar system “Most of the effort will now be on performance,” he adds.
On the investment fund side, there were 17 contractual investment funds managed by seven companies.
“Fixed income and money market funds are stable, but losing market share as equity funds pick up,” reports Oim. The most popular are funds based on central and east European equities - the Baltic stock markets themselves are relatively small.
On the fixed income side, bond investments are all foreign as Estonia has by law to try to run a balanced budget and thus has not developed a treasury market.
Estonia, and Lithuania have their currencies pegged to the euro, and both joined ERM-II, the mechanism that countries must belong to for two years before adopting the euro, in June 2004. Latvia will be repegging its currency from the Special Drawing Right to the euro in January 2005.
“We introduced an equity fund with units denominated in euros, which helped to sell our funds in Latvia and Lithuania”. “After Latvia replaces its peg, our cross border business will increase.” The investment company is also trying to sell its equity products in Finland, registering its UCITs under the EU passport. “In the short term this could be a bigger driver than local equity,” adds Oim.
Lithuania’s asset management market has lagged behind because of delays in legislation. However, in 2003 parliament approved both a UCITS-compatible law on collective investments, which finally allowed mutual funds to be offered to the public, and a second pillar system, which started operating in 2004.
According to Saulius Racevicius, managing director of VB Investment Management, the mutual funds market as measured by assets managed by members the Lithuanian Investment Management Association had grown to more than LTL550m (€159m), with global and central European equity funds the most popular at present.
Although still a young market overall, the current trends, according to Racevicius, include a switch from fixed income to riskier assets, accelerating growth of assets under management, and more cross border operations. With close to 90% of the capital of Lithuania’s commercial banks owned by foreign institutions, the Lithuanian market is also a platform for cross-border operations. VB Investment Management is itself owned by Sweden’s SEB Bank and sell its parent’s range of funds in addition to its own brands.