Pension funds returns: The case of Eastern and Central Europe Dariusz Stańko Warsaw School of Economics Warsaw, 28 May FIAP International Seminar „Investments and Payouts in the Funded Pension Systems”, Warsaw May 2009

2 Plan of this presentation purpose and range of analysis purpose and range of analysis impact of the financial crisis impact of the financial crisis returns until Feb 2009 returns until Feb 2009 investment policy and limits – impact on results investment policy and limits – impact on results Sharpe ratios Sharpe ratios accumulated returns for various cohorts accumulated returns for various cohorts general assessment and policy recommendations general assessment and policy recommendations Appendix: Appendix: data data methodology methodology returns and their volatility returns and their volatility gross vs net results (fees) gross vs net results (fees) impact of investment of pension funds impact of investment of pension funds

3 1. Purpose and range of analysis to report investment results obtained by pension funds from the Eastern and Central Europe as well as to report investment results obtained by pension funds from the Eastern and Central Europe as well as to find explanations for such results to find explanations for such results to discuss the impact of pension funds’ investment on local capital markets to discuss the impact of pension funds’ investment on local capital markets to answer the question – Have the expectations towards funded pension systems been met? to answer the question – Have the expectations towards funded pension systems been met?

4 1. cont. Purpose and range of analysis subject of analysis: subject of analysis: mandatory pension funds in Bulgaria, Croatia, Slovakia, Romania, Poland, Estonia mandatory pension funds in Bulgaria, Croatia, Slovakia, Romania, Poland, Estonia voluntary pension funds in Romania and Czech Republic voluntary pension funds in Romania and Czech Republic market as a whole, not individual funds market as a whole, not individual funds semi-gross investment results (upfront fees not included) semi-gross investment results (upfront fees not included) time horizon: until the end of February 2009, with accounting for 2008 financial crisis time horizon: until the end of February 2009, with accounting for 2008 financial crisis

5 2. Returns up till end of Feb 2009 all countries positive nominal accumulated returns yet effect of financial crisis highly visible all countries positive nominal accumulated returns yet effect of financial crisis highly visible only countries with longest maturity (CZ, POL, CR) positive real returns – time diversification matters only countries with longest maturity (CZ, POL, CR) positive real returns – time diversification matters negative real returns – crises vs short maturity (BG, SLO, RO) and conservative asset allocation (EE, RO) negative real returns – crises vs short maturity (BG, SLO, RO) and conservative asset allocation (EE, RO) returns volatility (standard deviation) the biggest in BG, CR, POL; 2008 year increased it considerably returns volatility (standard deviation) the biggest in BG, CR, POL; 2008 year increased it considerably

6 2. cont. Returns up till end of Feb 2009

7 2. cont. Comparison with stock markets (as of end Feb 2009)

8 3. Impact of the financial crisis

9 3. cont. Pension markets in 2008

10 4. I nvestment policy and limits – impact on pension results most of pension funds in analysed sample run conservative investment strategy as far as stock exposure is concerned: most of pension funds in analysed sample run conservative investment strategy as far as stock exposure is concerned:

11 5. Sharpe ratios mostly negative for short-term rates, local bonds and US long-term bonds if measured until end of Feb 2009 yet... mostly negative for short-term rates, local bonds and US long-term bonds if measured until end of Feb 2009 yet positive for all local bonds and for unhedged (local currency gains) US long-term bonds... positive for all local bonds and for unhedged (local currency gains) US long-term bonds... and positive for most local short-term rates and partly for hedged (USD gains) US long-term bonds... and positive for most local short-term rates and partly for hedged (USD gains) US long-term bonds if the 2008 financial crises is not accounted for (calculation horizon until Dec 2007)

12

13 6. Results so far - accumulated real returns for various cohorts negative values for all or most cohorts in all countries except PL (2005 and earlier), mandatory RO, CZ (2003 and earlier) negative values for all or most cohorts in all countries except PL (2005 and earlier), mandatory RO, CZ (2003 and earlier) the biggest loss for cohort entering in 2008 the biggest loss for cohort entering in ,7% EE funds A, -29,0% BG, -25,0% EE funds B, - 23,4% POL -34,7% EE funds A, -29,0% BG, -25,0% EE funds B, - 23,4% POL „average” group: -12,5% CR, % SLO funds A, B, -5,5% CZ „average” group: -12,5% CR, % SLO funds A, B, -5,5% CZ conservative funds: -7,9% EE [2,37% nom.], -0,7% SL [4,23% nom.], conservative funds: -7,9% EE [2,37% nom.], -0,7% SL [4,23% nom.], conservative funds not much help for 2008 disaster conservative funds not much help for 2008 disaster

14 6. cont. Results so far - accumulated real returns... early cohorts ( ): positive, CZ 2-6%, POL 43-63%, early cohorts ( ): positive, CZ 2-6%, POL 43-63%, medium cohorts ( ): getting worse medium cohorts ( ): getting worse mostly negative, -22,5% BG (2004), from -13% to -23% EE (A, B, C funds), mostly negative, -22,5% BG (2004), from -13% to -23% EE (A, B, C funds), relatively positive in CZ (from +3% to -2%) relatively positive in CZ (from +3% to -2%) positive in CRO (+8% in 2004) and POL (from +40% to +12%) positive in CRO (+8% in 2004) and POL (from +40% to +12%) late cohorts ( ): the worse late cohorts ( ): the worse severely negative: EE (-25-37% A; % B, % C), BG (-25-27%), POL (-21%-10%) severely negative: EE (-25-37% A; % B, % C), BG (-25-27%), POL (-21%-10%) negative: SLO (-11-10,5 A, B), CR (-9,5-5%), CZ (-2,5-5%) negative: SLO (-11-10,5 A, B), CR (-9,5-5%), CZ (-2,5-5%) defendable: SLO (0,15 to -0,9%, C) defendable: SLO (0,15 to -0,9%, C)

15

16 7. General assessment and policy recommendations results obtained so far results obtained so far not satisfactory in real terms but not satisfactory in real terms but effect of crisis and... low stock exposure in the past effect of crisis and... low stock exposure in the past until 2008 pension funds on average beat the short-term deposits and local bonds and most of local short-term rates until 2008 pension funds on average beat the short-term deposits and local bonds and most of local short-term rates time needed to recover (happening recently?) time needed to recover (happening recently?)

17 7 cont. General assessment and policy recommendations main drivers of results main drivers of results investment limits but also investment limits but also investment policy (sometimes much lower than theoretically admissible) investment policy (sometimes much lower than theoretically admissible) system’s maturity and timing with crisis system’s maturity and timing with crisis conservative fund not solution if saving in it for long-term during accumulation period conservative fund not solution if saving in it for long-term during accumulation period it does pay to save more aggressively for a long time (case of Poland) but properly timed switch to conservative funds a must when approaching retirement it does pay to save more aggressively for a long time (case of Poland) but properly timed switch to conservative funds a must when approaching retirement

18 7 cont. General assessment and policy recommendations main policy recommendations: main policy recommendations: life cycle (conservative!) funds needed but there are no magic solution (case of SLO and EE) life cycle (conservative!) funds needed but there are no magic solution (case of SLO and EE) what should be the default fund bearing in mind behavioural patterns of savers in mandatory pension systems? what should be the default fund bearing in mind behavioural patterns of savers in mandatory pension systems? what should be the „pre-retirement” period? what should be the „pre-retirement” period? how to ensure proper switching mechanism” how to ensure proper switching mechanism” education to the public about the nature of long-term saving and equity premium education to the public about the nature of long-term saving and equity premium help for investment decisions (multifunds) but also help for investment decisions (multifunds) but also help to discuss with reversal tendencies in funded markets help to discuss with reversal tendencies in funded markets more elastic investment limits COMBINED WITH changes in performance evaluation frameworks more elastic investment limits COMBINED WITH changes in performance evaluation frameworks

19 Literature Antolin P. (2008). Pension Fund Performance, OECD Working Papers on Insurance and Private Pensions, No. 20, OECD, Antolin P. (2008). Pension Fund Performance, OECD Working Papers on Insurance and Private Pensions, No. 20, OECD, Sharpe, W. (1994). ‘Sharpe Ratio’, Journal of Portfolio Management, 21(1), 49-58, available also at: Sharpe, W. (1994). ‘Sharpe Ratio’, Journal of Portfolio Management, 21(1), 49-58, available also at: Tapia, W. (2008). Comparing aggregate investment returns in privately managed pension funds, OECD Working Paper on Insurance and Private Pensions, No. 22, Tapia, W. (2008). Comparing aggregate investment returns in privately managed pension funds, OECD Working Paper on Insurance and Private Pensions, No. 22, Walker E., Iglesias A. (2007). Financial Performance of Pension Fund Systems around the World: An Exploratory Study, Final Report for OECD – World Bank, November 15, 2007, World Bank project on Investment Performance of Privately Managed Pension Funds, unpublished manuscript. Walker E., Iglesias A. (2007). Financial Performance of Pension Fund Systems around the World: An Exploratory Study, Final Report for OECD – World Bank, November 15, 2007, World Bank project on Investment Performance of Privately Managed Pension Funds, unpublished manuscript.

20 Data Sofia Group members inquiry, correspondence with institutions, literature and Internet search: Sofia Group members inquiry, correspondence with institutions, literature and Internet search: pension funds units or returns, pension funds units or returns, TBills and TBonds yields, TBills and TBonds yields, local stock and bond indices, US bond indices local stock and bond indices, US bond indices CPI, pension fees, stock market capitalization etc. CPI, pension fees, stock market capitalization etc. pension funds returns: industry averages (usually market share weighted average) pension funds returns: industry averages (usually market share weighted average)

21 Methodology pension returns calculation pension returns calculation weighted market share averages; not lagged aggregate weights (Walker, Iglesias, 2007: 10) – difference should not be important yet (short time horizon) weighted market share averages; not lagged aggregate weights (Walker, Iglesias, 2007: 10) – difference should not be important yet (short time horizon) survivorship bias effect acceptable (Polish OFEs: 0,54 bps 1999-Feb2009 for simple averages) survivorship bias effect acceptable (Polish OFEs: 0,54 bps 1999-Feb2009 for simple averages) discrete, compounded discrete, compounded TBills and TBonds yields TBills and TBonds yields wealth index as discussed in Walker, Iglesias (2007: 7) wealth index as discussed in Walker, Iglesias (2007: 7) US long bonds – hedged and unhedged versions US long bonds – hedged and unhedged versions stock returns stock returns price-weighted index (RO, CR) vs value-weighted (BG?, SLO, POL, EE) with dividends effect included price-weighted index (RO, CR) vs value-weighted (BG?, SLO, POL, EE) with dividends effect included

22 Methodology risk-free rate benchmarks, risk-free rate benchmarks, classical short-term rates (ex. WIBOR3M) classical short-term rates (ex. WIBOR3M) long-term rates (Walker, Iglesias, 2007) long-term rates (Walker, Iglesias, 2007) long-term local bonds if available long-term local bonds if available US long bonds – hedged and unhedged versions US long bonds – hedged and unhedged versions Sharpe ratios (Sharpe, 1994) – volatility of excess returns Sharpe ratios (Sharpe, 1994) – volatility of excess returns risk measures risk measures standard deviation of returns standard deviation of returns beta values against stock indices beta values against stock indices

23 Methodology: Benchmarks for pension funds stock indices dived by 50-80% in 2008 stock indices dived by 50-80% in 2008 price-weighted index (RO, CR) vs value-weighted (BG?, SLO, POL, EE) with dividends effect included price-weighted index (RO, CR) vs value-weighted (BG?, SLO, POL, EE) with dividends effect included risk-free rate benchmarks, risk-free rate benchmarks, classical short-term rates (ex. WIBOR3M) classical short-term rates (ex. WIBOR3M) long-term rates (Walker, Iglesias, 2007) long-term rates (Walker, Iglesias, 2007) long-term local bonds if available long-term local bonds if available US long bonds – hedged and unhedged versions US long bonds – hedged and unhedged versions

24 Volatility of returns

25 G ross vs net results (fees) in most cases semi-gross rates of return (mgmt fee) in most cases semi-gross rates of return (mgmt fee) net rates of return should take into account upfront fees net rates of return should take into account upfront fees * As of July 2009 to be lowered to 0,3%. ** To be lowered to 3,5 commencing *** To be lowered to 186 m PLN pa for assets above 45 bn PLN (equiv of 0,413%).

26 I nvestment of pension funds – impact on capital markets increasing domestic savings - market development (size, instruments, maturity) increasing domestic savings - market development (size, instruments, maturity) Czech Republic 4,8% of GDP (2007) Czech Republic 4,8% of GDP (2007) Bulgaria 4,1% of GDP (2007) Bulgaria 4,1% of GDP (2007) Croatia 7,7% of GDP, 8% of stock market (2007) Croatia 7,7% of GDP, 8% of stock market (2007) Hungary 11,1% of GDP (2007) Hungary 11,1% of GDP (2007) Romania 0,2% of GDP (2007), 1,8% of stock market (2008) Romania 0,2% of GDP (2007), 1,8% of stock market (2008) Poland 11,9% GDP (2007), 27,5% of stock market (2007) Poland 11,9% GDP (2007), 27,5% of stock market (2007) 2008 – stabilizer of local capital markets 2008 – stabilizer of local capital markets

27

28

29

30