Two years ago, in January 2005, Slovakia launched a fully funded mandatory pillar pension system to augment a pay-as-you-go system that had been in deficit since 1997. Last year intense competition in the sector saw the original eight players reduced to six.

A key factor in the shakeout was that the government had set down that by June last year the funds had to have gained a minimum of 50,000 members and that those that failed to do so would lose their licences and their members transferred to other funds that had cleared the hurdle. Participants were allowed to switch from one fund to another fund after one year and then every six months should they wish without penalty.

One of the surprising winners was the Aegon unit, Aegon dss, which moved from being ranked seventh of the eight in November 2005 to third of the six now. "We have seen substantial growth," says Mário Adámec, investment manager at Aegon dss.

"We attracted a number of clients during the transfer period starting last February. This was based on three factors: we had the best performance at that time, no management fee and highly motivated and active agents."

The key criteria for success appears to have been a link to an international financial services group, as the two local players were swallowed up by their ING and Allianz-linked competitors. And it is these links that determine their asset management choices.

"Our legislation states that each dss has to have three funds - a conservative fund whose assets can only be invested in bonds and monetary investments that are fully secured against currency risk, a balanced fund with not more than 50% invested in equities while at least 50% of assets must be secured against currency risk, and a growth fund with up to 80% in equities and 80% of which must be secured against currency risk," says Viktor Kouril, a board member of both CSOB dss and of CSOB AM. "Moreover each fund must have a separate portfolio manager. The legislation also details conditions that the portfolio managers have to fulfil in terms of education and experience in the financial sector. And the legislation also imposes a strict prohibition on the outsourcing of portfolio management."

"It is not possible to outsource asset management beyond the pension asset management company," Adámec. "It is allowed to use portfolio managers within the same group provided there are some working contracts with a physical person, not with the company. That means that each portfolio manager must be an employee of the pension asset management company in Slovakia."

But while institutional investors in Slovakia are mostly second pillar pension funds, third pillar funds and insurance companies are also in the market, Kouril adds. "They usually prefer low-risk
instruments and a large portion of their portfolios consists of SKK-denominated bonds, which are usually state guaranteed," he says. "Some structured and tailor-made products are being sold, mainly to insurance companies. However, as part of EU Slovakia accepts the ‘passports' of funds from other European countries. When such a fund is being sold in Slovakia, the distributor has to declare this to the national bank, which is our regulator. To sell a non-UCITS fund the distributor would have to follow a licensing procedure."

One company about to enter the institutional market is KB Asset Management, a subsidiary of the Slovenia-based KB Group. "This year we plan to establish a brokerage house so that we will be able to be ready to serve institutional clients," says Gabriel Hinzeller, portfolio manager responsible for asset management in KB Asset Management.

"We will open a brokerage house because we need a nominee to sell these products to retail and institutional clients. Our Slovene parent has funds in Luxembourg and Slovenia and it wants to distribute these funds in Slovakia. And we will be able also to market our funds not only in Slovakia but in the Czech Republic, Hungary, maybe Poland, all the countries round Slovakia, using an EU passport."

"In fact, foreign funds are sold in Slovakia quite commonly," says Kouril. "For example, CSOB AM is selling the funds of our shareholder, Belgian financial group KBC on the market. In addition, funds from ABN, Pioneer, Raiffeisen, ING and some other are sold."

"We have invested in some ETFs linked to South Korea and Japan," says Adámec. "According to the current state of the law, the only condition is that securities must be listed on the stock exchange of an OECD or EU member country. We can even invest in securities listed outside these stock exchanges provided that they are stated in a fund's statutes. But we cannot invest in hedge funds or in real estate funds, which is quite annoying given the evolution of our domestic and foreign real estate sector over the past few years."

The next key development on which asset managers are focusing is the adoption of the euro, which common consensus, in Bratislava at least, expects to occur on 1 January 2009.

"According to the current law we must hedge some part of the assets in each of our three funds against currency risk," says Adámec. "For example it is required that a conservative fund be fully hedged against currency risk, 50% of a balanced fund and 20% for a growth fund. But once we adopt the euro it will be easier to invest."

In fact this requirement represents a challenge for the pension funds as it is impossible theoretically to hedge 100% so in practice no security can be issued in a currency other than the Slovak koruna. "On the bond side, the Slovak economy is in good shape so the government plans very few issues next year," says Adámec. "So we will not have sufficient opportunities to invest in Slovak government instruments. I expect that after 2009, if everything goes to plan, Slovak pension asset management companies will be investing in euro zone countries' debt because the spread over bunds could be negative for Slovakia so Euro-zone countries will be more attractive for us. The Slovak equity market is not interesting for institutional investors because of privatisations, there are no new issues and the free float is very small so it is more or less for private individuals."

However, the hedging levels for balanced and growth funds do not pose problems yet because pension funds do not invest heavily in foreign assets.

"The current level of assets in the balanced and growth funds is sufficient for diversification," says Adámec. "The law says that there can be up to 50% of NAV invested in equities in a balanced fund and up to 80% in a growth fund but current levels are very low, ranging from 12-18% in a growth fund. So pension asset management companies are not using all of the possibilities and are still quite conservative. This is because nobody wanted to show a negative performance during the initial years of the reform, But in the coming years the ratio of equity investments will grow steadily and we will finally reach the level of, let‘s say, at least 50% in a growth fund in a couple of years."

One factor that could upset the funds' plans is the new government's policies. The populist left of centre Direction - Social Democracy (Smer) party, led by Robert Fico, emerged as the largest party from last June's general election. He subsequently formed a coalition with the People's Party - Movement for a Democratic Slovakia (HZDS), a grouping which led Slovakia into virtual isolation when in office in the 1990s through its attachment to crony capitalism and its heavy hand with opponents. The new government replaced an administration that, having ousted the HZDS, instituted radical reforms, including a transformation of the pension system, and ended Slovakia's isolation, steering it into the EU and Nato.

In opposition Fico had resisted the pension freeform but had consistently avoided stating what his alternative would be. Since he took office there have been indications that next year he will attempt to reduce the contribution flowing to the second pillar funds to 6% of a gross wage from 9%. There are also fears that the spending plans could threaten the economic growth he inherited, with double-digit GDP growth forecast for last year.

Such moves would restrict growth of assets under management of the pension funds, and therefore their asset management choices, and put accession to the Euro-zone under threat.

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