Cultural, economic and political variations remain but Krystyna Krzyzak finds that investment styles are converging

Central and eastern Europe (CEE) asset management continues to display strong cultural biases.The risk-averse Hungarians and Czechs are still wedded to fixed-income products, while Polish investment sentiment has propelled the Warsaw Stock Exchange into being as the region's best capitalised bourse.

Nevertheless, investment styles are converging, legislation permitting, driven, in most cases, by outstanding economic growth, and by the global ownership of the main players.

Annual third-quarter GDP growth in 2007 ranged from 11.1% in Latvia and 10.8% in Lithuania to 9.4% in Slovakia, 6.4% in Poland and Estonia, and a sad 1% in Hungary. While incomes have risen significantly in the high-growth countries, they have fallen by some 3% over the last two years in Hungary. As Peter Heim, regional investment director at Aegon in Budapest explains, Poles remain the biggest risk takers while Hungarians are unlikely to be until the country regains strong economic growth.

In the Polish pensions system the current outstanding issue is the lack of legislation on payment schedules. A matter of increasing urgency given that the first payments from the second pillar are due in 2009. A prolonged political crisis, leading to early general elections in October 2007 interrupted the drafting of the relevant legislation. In addition to covering the payment entities themselves, regulations also have to decide on issues such as the pensions entitlements of spouses. In the current legal vacuum, pension funds will not be able to retain the retirees' funds but have no destination nor stated system of paying over the accumulated funds.

An IT system also has to be designed and implemented. Although only some 2,800 retirees will require payment in 2009, delays could potentially undermine the whole credibility of Poland's pensions reforms, notes Michal Szymanski, CIO and member of the management board of Commercial Union Pension Fund. However, given the political costs to the new government, Szymanski believes a system will be in place in time.

The reformed pension system itself has otherwise been extremely successful, accumulating PLN142.8bn (€39.5bn) as of October 2007, a year-on-year rise in Polish zloty terms of 31%. Asset growth has been propelled by a rise in the number of members, to 13.08m from 12.29m, falling unemployment and a strong economy, which in turn has boosted wages. Emigration following EU accession is also pushing up earnings, although it has inevitably also reduced the number of members paying in, especially in the 20 to 30-year-old age bracket.

Returns, however, came under pressure in 2007, especially given the relatively high proportion of assets invested in equities, and were some five to six percentage points lower than in 2006. "The volatility of stock markets and rising inflationary pressures - from increased food and commodity prices and rising wages - are posing challenges for the pension fund investments," says Szymanski. Polish pension funds have adjusted their asset allocation as a result, including raising the equity portion by some 2.5 percentage points to 37%. "Despite stock market volatility Polish pension funds were equity buyers because the domestic environment has been favourable and is sustainable in the near future," Szymanski explains.

The allocation of treasury bonds fell to 57% at the end of October 2007, from 62% a year earlier, while that of non-treasury bonds, including corporate and mortgage bonds, rose to 1.5% from 0.7%. The growing corporate bond market is providing welcome diversification within the country's strict investment limits for pension funds. Senior members of the
new government have indicated a willingness to discuss changes in the current limits, including the 5% limit on foreign investment. This would be welcomed by the industry. "International diversification should be enhanced," adds Szymanski. Even within this limit, the requirement for such foreign securities to have investment grade ratings, and the fact that the pension fund management companies must pay brokerage, custodial and related costs - unlike domestic investment, where the fund itself bears the charges - make foreign investment difficult.

Polish investment funds (TFIs) are also performing strongly, with PLN144bn in net assets in October, according to Polish analytics firm Analizy Online, a year-on-year growth of 62%. This is by far the biggest investment fund industry in the CEE region and is becoming increasingly competitive with new players. Last November HSBC started distributing 40 funds in the country. In addition a number of senior executives from established investment fund companies have left to set up their own firms. In September, Sebastian Buczek, former CEO of ING TFI, set up the Quercus TFI. Locally domiciled funds continue to predominate, partly because of the continuing strengthening of the zloty against the dollar and euro.

The fastest growth, of 183%, has been in equity funds, which totalled PLN48.3bn at end-October, of which PLN39bn was domestic equity funds. "The support from this has come from the performance of the Warsaw Stock Exchange," says Zbigniew Jagiello, CEO at Pioneer Pekao Investment Fund Company in Warsaw.

In the first 10 months of 2007 the main WIG index returned 10%, despite the global stock market corrections that inevitably affected Poland, and Polish companies have reported good results, in line with strong economic growth. Small to mid-cap stocks have outperformed the blue chips, with the indexes returning close to 20%.

In addition to equities, clients also invested in balanced funds, at the expense of low-risk funds. According to Jagiello, funds based on Asian, Pacific and emerging Europe markets proved popular in the second half of 2007. In contrast, bond funds have been experiencing an exodus, with net assets down by 20% to PLN9bn. "Because of the new cycle of rising interest rates in Poland, the performance of bond funds is worsening," adds Jagiello. "The return [2-4% in the year to October] is not bad, but in the short term we do not expect them to do better than money market funds or deposits."

In the Hungarian mandatory pension fund system, the longest-established in the region, assets (by market value) totalled HUF1,921bn (€7.6bn) at the end of September, a yearly growth of 32.5% in Hungarian forint terms, according to data from the Hungarian Financial Services Authority (PSZAF). This has occurred despite falling wages - in sharp contrast to other countries in the region - resulting from the current government's fiscally austere policies.

The main challenge confronting the 20 fund management companies is the shift from single to multi-fund portfolios. By the start of 2009, all companies must offer their clients a choice of conservative (bond), dynamic (equity-weighted) and balanced portfolios (see p25). The changeover is causing the traditionally bond-weighted pensions asset market to shift towards equities. According to the PSZAF, the equities portion of the market as a whole had grown to 12% at the end of September from 9% a year earlier.

The market is aiming for a smooth transition to avoid disruptive sell-offs in the bond market, notes Gabor Borza, managing director of ING mandatory and voluntary pension funds. Multi-funds are already available in Hungary's voluntary pension funds, although Borza estimates that only 3-4% will actively choose their portfolio. The rest will be allocated according to the time left to retirement: those with 15 years or more go to the equity-weighted fund, those with five or less to the conservative bond-based portfolio, and those in between to the balanced fund.

At Aegon, which intends to launch its three funds in mid-2008, the aim was to boost the equity portion by the end of 2007 and to around 40-45% by mid-2008. "We don't view equities as the only way to diversify," adds Heim. "There are also alternative assets such as hedge funds, real estate and real estate developers. We also intend to invest into private equity."

In the equities portion, meanwhile, most are in foreign - primarily developed - markets. Despite global stock market turmoil, Heim remains optimistic about a recovery in the US from mid-2008, and in contrast to many other fund managers in the region, believes that emerging markets will have to suffer an inevitable correction. "If you are a long-term equity investor, the best time to invest is not in a bull market but in the sort of market we are experiencing now," he adds.

The move to multi-funds has been welcomed by the industry. However, the IT system introduced in 2007 to centralise premium collections and declarations by the tax authorities - previously all contributions were collected by the funds themselves from employers - was still not functioning adequately by the end of the year. Premiums have continued to flow in, but without the declarations, making it difficult to identify who they belong to. "There have been delays and problems, and we will not be introducing a multi-fund system until the centralised system is working properly," notes Borza.

The shift by pension funds to equities will in turn create shifts in the portfolio structure of the investment fund industry. "Pension funds will be big buyers of equity funds. They will not be able to manage, say, Latin American equities," predicts Balazs Benczedi, CEO at ING Investment Management Hungary, the country's second biggest investment fund management company. "The Hungarian mutual fund industry has huge growth potential; it used to be completely unreachable and unknown."

This has already been borne out in the case of publicly offered domestically registered open-ended funds. According to data from the Association of Investment Fund and Asset Management Companies in Hungary (BAMOSZ), net asset value grew by 32% on the year at end-October to €8.1bn. In the case of others, such as real estate, derivative and capital guaranteed funds, it rose by 27% to €4.5bn. Real estate funds suffered a small outflow as returns have been close to far less risky money market funds.

In the case of domestic open-ended funds, while money market funds still account for the biggest share, there has been a shift into equity, a trend that Benczedi belives will continue. In terms of asset management, the market remains highly concentrated, with the top five managing some two-thirds of all assets.

Benczedi believes that the next three years will be the era of foreign funds; ING itself acts as third-party distributor, largely for institutional clients. "Until 2006 there was no retail third-party distribution," he adds. "We then realised that clients needed diversification and did not have their own products."

In the legislative arena fund managers had a relatively peaceful time except for having to reduce their fees. Asset management and administration fees were capped at the end of 2005. In 2009, the asset management fee will fall to 0.8% from 0.9% this year and the administration fee will drop to 4.5% from 6% by 2009 depending on whether the centralised collection system is working.

A more serious threat loomed in 2007, when a member of parliament proposed that mandatory pension clients who would, in terms of accumulated funds, have been better off remaining in the state system, should be allowed to return to the first pillar. Parliament rejected the proposal.

This was not the case in neighbouring Slovakia. Following legislation in November, members of the second pillar will, from the start of this year, have six months to decide whether or not they want to opt out. In addition, the minimum period for being a second pillar member has been raised to 15 years from 10. The change has created great uncertainty for the relatively young system - contribution collection only started in 2005. Erik Osusky, portfolio manager at AXA SR pension funds, estimates that the time reduction may force some 5% of members to leave, while the opt-outs could be anything from 5% to 15%.

"With this uncertainty we cannot allocate assets as we used to," he says. "Every pensions company has to build up liquidity in case higher numbers leave. Equity is not a big issue because most of our investments are foreign and there is no liquidity problem. The biggest problem is with government, largely Slovak crown, bonds. The liquidity of these assets is very low."

As of early December the Slovak second pillar had some 1.5m members and assets of SKK48.6bn (€1.5bn). Of these, 66% were in growth (equity-geared) funds, 4% in conservative (fixed income-based) funds in 30% in balanced funds, although currently all three types follow relatively conservative strategies. Osusky believes that inevitably the conservative and balanced funds, with their older membership profiles, will see the biggest exodus.

While the government changed the pensions law in order to plug the deficit in the first pillar social security budget, it has failed to appreciate the Slovak public's propensity for savings. In the case of investment funds, net assets grew by 20% over the year to October to SKK157.3bn.

"It was a successful year for us," says Martin Duriancik, board member at Tatra Asset Management (TAM) in Bratislava. While the market remains dominated by money market funds, there has been a growing appetite for more complex structures. Capital protected funds became increasingly popular and TAM also took advantage of legal changes in 2007 to launch a real estate fund focussed on commercial property.

According to Duriancik, the strong appreciation of the Slovak crown in 2007 - in January-November it strengthened by 3.6% against the euro and 13.6% against the dollar - was the year's only significant play, and the reason for now favouring real estate funds. As Duriancik explains: "The currency appreciation will finish soon. Real estate is the only part of the Slovak capital markets that can capture the potential of Slovakia's economic growth."

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