It’s easy to feel optimistic as you pause for breath at the top of Lisbon’s Bairro Alto. Below and away to the right the River Tagus sweeps out into the Atlantic towards the new world. To the left the futuristic Vasco da Gama bridge recalls the hero of Portugal’s golden age and suggests a new era of modernity. The asset managers in Lisbon are clustered along the Avenida da Liberdade, just below, heading away from the waterfront. It’s lucky they have the view so near at hand. There aren’t many other causes for optimism. “Lots of people in New York and London judge Portugal on the statistics and decide its not worth being here. But they are misinterpreting the opportunities available,” says Leonardo Mathias, head of Schroders Investment Management in Portugal. Mathias is an optimist. Certainly, the statistics on Portugal can be deceptive, but not so as to cause undue pessimism.
In terms of assets under management relative to GDP, the pensions industry is bigger than Spain. “But that doesn’t mean there is a real pensions market,” says Adelaide Cavaleiro, director of BBVA Pensions. Cavaleiro is not such an optimist.
Although there is E15bn in the private pension system, most of that is accounted for by either the banking sector, which is outside the social security system, or former public sector monopolies which run their own funds. “There may be E15bn in the system,” says Rui Guerra of Mercer Investment Consulting in Lisbon. “But there’s really only E3bn in the market, the rest is either run by banks or captive public funds.”
To compound the problem, the few opportunities for foreign managers have actually been reducing recently as funds have backed off from the areas where they would be most likely to outsource management.
Cavaleiro’s BBVA fund is typical. The E150m under management is almost all from the BBVA pensions fund and Cavaleiro has now been asked to develop what she calls an ‘immunisation strategy’ by Madrid. The pension fund liabilities are huge in relation to the size of BBVA’s Portuguese subsidiary and after three years of poor performance head office isn’t prepared to tolerate the volatility any more. Just how bad has it been? “Bad,” says Cavaleiro.
She may not want to discuss her performance, but it can’t have been that bad by Anglo-Saxon standards. The problem, as for so many other funds, was an overweight in equities. But in Portugal that overweight meant just 30%.
“Legislation imposes a general limit of 55% on equities which can be increased in certain circumstances”, explains Bernie Thomas of consultants Watson Wyatt, “This tends to influence how pension fund investors look at the situation. Pension funds are still relatively new in Portugal and investors do not have a large risk appetite.” The last three years performance numbers have served to consolidate a natural inclination towards bonds
It’s a similar story at the Bank of Portugal pension fund. The E900m BdP fund is one of those captive funds. “We’re not in the market as such,” says Helena Adegas, executive director of the fund. “We don’t offer plans. Our sole purpose is managing the employee fund.”
Until recently, the fund’s interactions with the rest of the industry was limited to awarding sub-advisory mandates. Now they’ve stopped doing that as well. “The costs of third party managers outweighed the benefits,” says Adegas frankly.
The fund was using third party managers particularly for equities. It has recently reduced its equity allocation to below the Portuguese average of 20%. And now implements that using ETFs rather than external managers. The fund’s main interest is getting the allocation decision right, and they were increasingly uncomfortable with the bets managers were taking.
“We wanted predictability,” says the fund’s economist, Miguel Branco. “And ETFs are much easier to administer than fund managers, because the information needed for performance and risk is available through the usual data providers.
Many Portuguese funds are turning to property as an alternative to equities. In part because the Portuguese tax system makes it an efficient form of investment. And in part because lots of companies have substantial property portfolios and in tight economic circumstances it makes sense to move these assets into the pension fund. It has proved a good bet over the last few years as Portugual has shared in southern Europe’s euro-driven real estate boom.
The BdP fund has a particularly large property portfolio, even by Portuguese standards, of around 15%. And it is the one area where the fund still uses third party managers.
The real estate portfolio provides a yield of over 7% before capital appreciation is taken into account.
For other funds the alternative to property has been hedge funds. Some have allocations of 15-20%. Guerra suggests that those with such high allocations may not have a proper understanding of what they are getting involved in. “The most important thing for us is that our clients understand what hedge funds are,” he says. “And our clients tend to have lower allocations to the asset class.”
The main cause for optimism is the prospect of social security reform. “The pensions business is driven mainly by two factors,” says Francisco de Medeiros Cordeiro, general secretary of AEGFP, the Portuguese pension funds association. “Social security and the tax system. If the government doesn’t defer taxation until the point when the benefits are paid out there is little incentive for companies to set up pension plans; and if social security is too generous then people don’t feel the need to save for retirement.”
Currently employees contribute 11% of salary and employers a further 23.75%. Retirees can receive up to 80% of salary average over 15 years. Contributions and benefits are uncapped. So high level executives making ø100,000 can retire on 80% salary from the state. “If I was running a business,” says Cavaleiro, “I wouldn’t see a pension fund as a priority.”
Companies can include pension contributions up to 15% of total labour costs (25% in the sectors not covered by social security) when calculating profits for tax purposes. “This limit has been in effect for a long period,” says Medeiros Cordeiro. “But it should be raised now that contributions have increased because of market losses. Companies are being penalised twice: first by the market and then by the tax system.”
The government is in the process of introducing reforms to this system, although the start date has just been pushed back a year to 2005. Under the proposals there will be three tiers. All salary in the lowest tier will be subject to the present compulsory social security contributions. Any earnings that make it into the next band will have the option of going into private DC scheme. And contributions from the top slice of earnings, expected to be over ten times the minimum wage, you can, in theory invest how you want.
In practice, there will probably have to be restrictions. “They won’t be so liberal as to just let you go out and buy a new car if that’s what you want,” says Mathias. “Because then everybody would just go out and buy a new car.”
This is the bigger problem: the Portuguese haven’t yet come round to thinking about the need for retirement savings. There are individual DC schemes available in banks, but people buy them for the year-end tax break, not because they are genuinely concerned about retirement. It’s a new concept for the country. “People are becoming aware of the need to save,” says Cavaleiro. “We’re seeing old people with money here for the first time.” Once people get accustomed to that, there may be grounds for further optimism.

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