In Hungary, the first pension funds to supplement the basic state provision came into being in 1993. These were voluntary ‘mutual' schemes. The closest equivalent in western Europe is the third pillar. In Hungarian pensions terminology third pillar means voluntary and second pillar means compulsory.

Today the voluntary mutual schemes boast 1.3m members, with employer and employee contributions incentivised through tax breaks.

A milestone in the development of Hungary's pensions system came in 1996 when a part of the state pay-as-you-go pension system was replaced by a fully-funded system based on compulsory contributions. Currently this system has some 2.5m members.

By the end of 2005, Hungarian pension funds owned total assets of HUF1,713bn ( €6.1bn).

The law sets out the assets in which Hungarian pension funds may invest their funds. Among the assets which legislation provides for, the most important are state bonds, equities, investment funds, futures, options, repo and swap deals - and real estate. The law also specifies the investment limits relating to the particular asset classes. For instance a pension may invest maximum of 10% of its assets in real estate.

The officials preparing the decisions at the time of the introduction of mutual pension schemes in 1993 justified the limit of just 10% on the basis of experiences in other countries as well as the uncertain
situation of the real estate market at that time. They also referred to the fact that the government
securities were considered the safest investment for pension funds.

Based on data provided by the Hungarian Association of the Investment Fund and Asset Managers (BAMOSZ), whose members manage 83% of pension fund assets, pension funds have an average allocation of just 1.15% to real estate, way below the 10% limit. This fact always amazes the executives of the pension funds of other EU counties, as does the fact that Hungarian pension allocate just 8% of their assets to equities (both domestic and foreign).

It is easy to explain the high proportion of government bonds in Hungarian pension fund portfolios. Hungary is virtually the only one of the former communist states where the successor organisation to the communist party is in power. By nature it has never considered the curb of the state budget deficit a priority and its analysts expect the budget deficit for the year 2006 to be 10.2% of GDP.

The Hungarian government has financed the deficit by issuing government papers and taking out foreign loans. This crowding-out effect has been a distinguishing feature of investments in Hungary since the regime change in 1990. Hungary's accession to the Euro-zone might bring about a change in the crowding-out effect of the government securities, but this is not expected before 2013 at the earliest.

Given that pension funds make up only a fraction of the investment market in Hungary, one should also look at the practice of the Hungarian
institutional and private investors in general. In comparison to the other asset classes real estate has been the most dynamic.

One reason for the relative lack of interest in real estate previously was the high yield of the Hungarian state bond, which diverted attention of investors from the similarly secure opportunity of investing in real estate business. We should also note that in Hungary fewer real estate investment projects are available for the institutional investors than in the countries with a more consolidated market environment.

In 2000 this process was stimulated when the government granted tax relief to real estate investments. Although the benefits were withdrawn last year, they were sufficient to boost the real estate market.

Hungarian institutional investors are still learning about the potential of the Hungarian real estate market as an investment vehicle, although the reallocation of the investments to this asset class has gradually started to materialise.

I share the view of those who believe that real estate investments will take an increasing slice of total investments in the years to come. Demand from institutional investors yet to fully discover this area will drive demand in the real estate market further.

At the Pharmacy Fund we recently moved into real estate by buying an office building in Budapest. The deciding factor will be how these market participants see their future prospects. If they believe that the Hungarian economy, following the restrictive programme introduced by prime minister Gyurcsány, will achieve sustainable growth in the long run, the effect on the Hungarian real estate market will be beneficial. If not, the funds available to investments - be it in Hungarian or foreign possession - will turn to safer areas promising a better return.

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