Among the challenges facing Spain’s pension funds is regulatory sclerosis, George Coats writes

Pension funds in Spain are waiting for new investment guidelines. And they are due any time now. The problem is they have been due any time now for quite a while. “We have been talking about changing pension fund regulations since 2003, so for more than four years,” recalls Sebastián Larraza Sola, a partner responsible for institutional clients at Madrid-based consultancy International Financial Analysts (AFI).

There were hopes that the changes would be implemented earlier this year. Then the timetable slipped to the end of the year. And now it appears to be slipping again. “We hope that the regulations will be implemented in the near future - maybe in December, maybe not,” says Manuel Alvarez, head of pensions and personal life insurance plans at Caser, an insurance company that is jointly owned by a number of savings banks. “The problem is that it takes such a long time to go from a bill to a law. So while I hope I don’t expect that we will have it before the next general election in March.”

However, Iñigo Bilbao-Goyoaga Sagarduy, country manager at AXA IM, is more optimistic. “A reform is going to take place and we expect it before March, before the next election,” he says. But he concedes: “We have a regulatory challenge.”

The ‘when’ is important because the gap between an announcement that a change is going to be made and its implementation has given rise to a regulatory black hole.

“We had a very liberal system and we could diversify into all kinds of things with only slight limits,” recalls Alvarez. “Then the government thought that perhaps some newer investment instruments like futures, options and hedge funds should be regulated. But as it has not yet issued the regulation we have had to disinvest from some alternatives.”

The government signalled what the new regulations might look like by changing the investment guidelines for investments funds. “Investment fund regulation and pension fund regulation go more or less the same way but after a time lag - the supervisor for mutual funds, the CNMV, has more people, technicians and resources than the pension funds supervisor, the DGSFP,” says Larraza. Then last year we had new regulation for investment funds on hedge funds and funds of hedge funds so now asset management houses can distribute and launch these funds in Spain. And they want to follow this example for pension funds. Pension funds are in the market for hedge funds and other illiquid products because they require a long-term investment horizon and with cash flow matching and you have to guarantee the assets.”

But while pension arena players are anxious for an end to the investment limbo, expectations of what will be in the regulation are muted. “From what we hear from our legal advisers this reform is not going to be substantial,” says Bilbao-Goyoaga. “Perhaps the most important change will be that real estate and private equity will be regulated and so it will be possible to invest in those two asset classes.”

“We have two ways of financing corporate pension liabilities: company qualified pension plans and group insurance policies,” explains Guillermo Ezcurra, who is responsible for the employee benefits programme arm at the March UNIPSA group, a subsidiary of Banca March, and a partner at independent actuarial consultancy Aserplan.

“A company qualified pension plan is only one product: it has to have a control commission with representatives of the employer and employees, often an employee majority. But insurance companies can create a product in many different ways which gives the company more freedom of action: it has no control commission and offers more flexible financing because the legislation in this area is not so clear for insurers. But most consultants agree that there will not be much difference in terms of what each instrument delivers as a final pension.”

And in addition to corporate pension funds there are also individual pension products.

“The average gross return last year was 5.93% and inflation was 2.7%, so there was not really much real return considering that equity has been surging for more than three years,” says Andrés Martín at Mercer in Madrid. “But people accept this. The local average asset allocation is 60% in fixed income and 40% in equity.”

“Returns are generally not very impressive, often they don’t cover domestic inflation,” says Valentin Fernandez, strategy director and responsible for institutional investor relations at Fonditel, the pension fund of Telefonica de España.

“I think the priority for the main managers, which belong to the banks, is not to offer a good return but to make the clients captive, offering a wide range of products - mortgage, deposit and pension plans - but not to offer good returns. There is a lack of culture in terms of what long-term savings like a pension plan means.”

That might work for the general public but what about the industry? “If you try to convince trustees of the importance of diversification of pensions assets they usually don’t have the culture to understand properly the difference between one piece of advice and another,” says one industry insider. “One can try to point out that there is value, for example, in having a performance evaluation study distinguishing between different sorts of asset classes by country, by type of management (active, passive and so on), or by type of asset (between, for example, small caps and big companies). But they say ‘it’s very interesting but what I want is the minimum for compliance with article so-and-so of the special pensions legislation and at the minimum price’. That’s what a trustee without an investment culture can understand.”

“Our pension fund system is very strict about the kind of costs that a pension fund has to pay, basically it’s the management fee and the depositary or banking fee, and no more than that,” says Alvarez.

“And our market is very special because there is a short list of large occupational pension plans and a long list of people who are trying to manage them. So there is a lot of competition and as a result the price is always very low.”

However, does the competition extend into the area of performance? “The fees that pension managers in Spain get are lower than in other countries but at the same time the value they add for these fees is also lower than in other countries,” says Ezcurra. “If you analyse the information ratio of even the big pension plans in Spain you see no extra alpha in exchange for the risk accepted, and what disappoints me about this is that I don’t see any reaction against it in the market. This suggests that most control commissions - most trustees - are not analysing returns and investment management of the pension fund from a professional perspective.”

“Many trustees have no aspirations higher than meeting inflation or maybe beating it by a percent but no more than that,” says Alvarez. “It doesn’t matter to them if the IBEX has a return of 20%, they prefer to have 4% or 5% every year. And the employers are interested in paying the money and avoiding problems, in having some kind of return that avoids risks. So you can’t invest 70% in shares because they would be concerned about the risk involved.”

“Many asset managers are putting the cart before the horse,” notes Bilbao-Goyoaga. “We are talking about having a discussion about alpha when performance is still not the most important thing for the pension fund. We need to solve the first before going onto the other.”

“Competition in performance would mean trustees would have to have a lot of information and process it in order to rank different managers,” adds Alvarez. “Comparing different offers in terms of volatility and returns is not so usual in Spain; perhaps we don’t have that kind of culture. Perhaps in the future our mentality will change, but not yet. It could be better if we managers were to have fees related to performance.”

That is the route followed by the pension fund of energy utility Endesa. “Fees are low in Spain but I have worked in the pension manager’s business and I don’t think there is always a relationship between fees and service,” says Jaime Sánchez-Cano Torres, director of pensions Endesa. “Maybe you can pay more but you won’t get more because of the size of the teams and the way they work are the same. What we try to do is to pay a minimum fixed fee for all the administration processes and then pay a success fee for the investment in terms of the ratio between our performance and the rest of the corporate pension plans.”

M&A activity left Endesa with 20 separate pension plans. “It was a real mess to manage all these schemes so we put them all into one,” says Sánchez-Cano. “This big pension plan has assets of about €2.4bn but only€1.3bn is under management because some of the portfolio is in insurance policies or in what we call equilibrium plans - money we owe to the plan that we will repay after a 10-year period that will end in 2011.”

And the €1.3bn has been placed with one manager, iberCaja. “In Spain it is not common to have different managers for the different kinds of assets, you have a manager that is both the investment manager and also does all the administration processes and usually for low fees,” says Sánchez-Cano. “We knew iberCaja from our pension plans in Aragon, and we chose them because their performance in the past was good and up to today iberCaja has consistently been better than the rest of the corporate plans. Last year it was 6.72%, four points over inflation, and in 2005, the year of the merger, it was 8.74% with inflation at about 3.7%, which was very good in Spanish terms that year. So we gladly pay the performance fee.”


However, most funds are not so organised. “There is no tradition of pension fund management here,” says Larraza. “Usually a company’s finance department finds some time to manage the assets, but there are very few entities with a dedicated investment management team so usually it is nobody’s core activity. This is a problem because pension funds usually make their investment decisions at the end of the year to gain some fiscal benefits and they are not thinking that they need a certain amount of money for the future. We just don’t have a culture that says savings must be made to maintain a certain standard of life in retirement. And we don’t have life cycle funds, we don’t have life-style funds, we only have pension funds and insurance products.”


But how is it that as a sector Spanish pension funds are allowed to underperform?

“It’s all due to the fact that the social security pension covers more than 85% of an average salary,” says Fernandez. “It is unsustainable but in the meantime it reduces the attractiveness of savings for the long term, because many workers know that at the end of their working life they are going to receive the bulk of their salary so there is no incentive to save more.”

But instead of encouraging pensions savings the government appears to be reducing their attractiveness.

“Tax incentives were reduced last year,” says Martín. “People contribute to a pension plan until they are 65. Up until last year the ceiling on all contributions to any pension plan it was €8,000 until the age of 50 and then an extra €1,250 every year until 65, so up to an extra€24,250 and corporate contributions would be added to this. Now people younger than 52 can only contribute a maximum of €10,000, or 30% of net income, and those over
52 a maximum of €12,500, or 50% of
net income.”

“People are starting to get a little worried about pensions in this country, but just how worried they are becoming is the result of a combination of their salary level and age,” notes Ezcurra. “People start to think about it when they reach 45-50 and after their annual earnings reach €75,000 and above. At that point they realise that with the maximum state pension being €32,068.26 per year in 2007 it will represent a replacement rate of only a fraction of their salary. But under the age of 40 employees, even those with a high salary level, are just not very concerned about it. They are more worried about the education of their children and paying the mortgage - by culture Spain in a home-owning society.”

“House market returns have been so high over the past seven years that people are moving their pension plans to houses looking for that mid-term performance,” says Martín. “Property is becoming a pension plan because the tax incentives for houses are better than for a pension plan.”

“Politicians claim that the Spanish pensions system is healthy, that the social security system’s contributions exceed the payouts, but this is due to the high level of immigration and rising employment seen in recent years and that just buys time because all these people paying social security contributions will get a pension in the future,” adds Ezcurra. “But politicians lack the courage to say that although today the maximum social security pension is around €32,000 per year, in 20 years it will be reduced to balance the social security budget.”

“A couple of years ago there were discussions about a major reform of the pension fund law including suggestions of creating simple long-term savings accounts into which a saver could put all sorts of assets - bonds, equity, property, whatever they want for the long term - for their retirement,” says Larraza. “But in the end they didn’t do it. Maybe the government was aware of creating something very different; had the changes been implemented they would have represented a major change to the system, and maybe because of this there was pressure from the major investment companies. Instead the authorities came up with a complex and not very useful product, a systematic individual savings plan, the PIAS. But it’s quite complicated, it is not for retirement, it’s got other horizons, and it doesn’t have fiscal benefits.”

“The second pillar in Spain is not growing at all, and the third pillar, the individual plans, has been decreasing in the past 18 months,” says Valentin. “This is due to two factors: first the big banks prefer to offer savings products to clients rather than pension plans and second the volatility regulation and because over the past year the authorities have created fiscal insecurity.”

“The problem here is that only big companies have an occupational pension plan,” says Alvarez. “And the system is not growing - small and medium companies are not promoting new pension plans. Perhaps we need more fiscal incentives but more importantly trade unions and the employers are not convinced that it is necessary to have a supplementary pension.”

They may be wrong. “The authorities are talking about changing the formula used to calculate the public pension,” says Larraza. “Some years ago it was proportional to a person’s last year’s salary up to a ceiling, now it is based on the last 15 years’ salary and they are discussing making it the whole career. The more years used for the calculation the lower the pension because normally people get more money the longer they have been working.”