18 September 2009, Sofia, Bulgaria

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INTRODUCTION, RESULTS AND INTRODUCTION, RESULTS AND EXPERIENCES OF THE EXPERIENCES OF THE

MULTIPORTFOLIO SYSTEM IN THE MULTIPORTFOLIO SYSTEM IN THE HUNGARIAN MANDATORY PENSION HUNGARIAN MANDATORY PENSION

FUNDSFUNDS

18 September 2009, Sofia, Bulgaria

Csaba NagyCsaba NagychairmanchairmanHungarian Association of Hungarian Association of Pension FundsPension Funds

Association of Pension and Health Funds

Contents

Background Drawbacks in competition - Pillar 1 vs Pillar 2 Pressure to improve - Legislative changes in 2008 Implementation of multifunds Accounting unit based approach Post implementation experiences Evaluation of the Hungarian multifund system An alternative approach - „Target date (lifetime) funds” system Conclusions

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Background Introduction of funded Pillar 2 in 1998

• Rapid growth of mandatory pension funds• Participation mandatory for first-time workers• Entry was open for active workers upon voluntary decision before 01.09.1999• Option to return upon retirement to social security pension scheme until 2002• Management of assets in a single fund

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Membership, thousand persons

2955 2983

1339

2280

2021

22512192 2304

2403 2511

2788

2655

0

500

1000

1500

2000

2500

3000

3500

Nu

mb

er

of

me

mb

ers

0,0%5,0%10,0%15,0%20,0%25,0%30,0%35,0%40,0%45,0%50,0%55,0%60,0%65,0%70,0%75,0%80,0%

ac

tiv

e p

op

ula

tio

n c

ov

ere

d

Number of members in percent of active population

Assets in million Euros

69826019

6305

7813

4830

3562

2153

17531154

353664

115

0

1000

2000

3000

4000

5000

6000

7000

8000

9000

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009 Q

1

Ass

ets

in m

illio

n E

urs

0,0%

2,0%

4,0%

6,0%

8,0%

10,0%

GD

P %

assets in million euros in percent of GDP


Drawbacks in competition Pillar 1 vs Pillar 2

• Guaranteed growth of state social security pensions based on „Swiss indexation” (i.e. the average of the consumer price index and the wage index);

• Promises by politicians: pensions for 13 or even 14 months in a year• Unattractive real returns of mandatory pension funds

Real return on overall portfolio of mandatory pension funds (%)

-4,0%

-2,0%

0,0%

2,0%

4,0%

6,0%

8,0%

10,0%

12,0%

2001 2002 2003 2004 2005 2006 2007

– Average real return in period from 2000 to 2007: 1.7 %

Loss of trust in the multi-pillar system

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Reasons for underperforming returns

The proportion of the government securities within pension fund’s investments in 2000-2006: ~ 70%

• Relative high government bond’s yields• Frightening effects of the stock exchange crisis 1998• Short-term approach (a „wrong year” involves competition drawback at member

recruiting)• Publishing of only 1 year’s yield

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There is no possibility to take yield advantage of higher risk assets

Yields of Hungarian government bonds and shares (1997-2007)

0,0

1,0

2,0

3,0

4,0

5,0

6,0

7,0

8,0

BUX; index ofblue-chipsshares listed onBudapest SEMAX; index ofHungarianGovernmentBonds


Pressure to improve - Legislative changes in 2008

• Introduction of the multiportfolio’s system (from 1 January 2008 it’s an opportunity, from 1 January 2009 it’s compulsory)

• Introduction of the accounting unit based records system (from 1 January 2008 it’s an opportunity, from 1 January 2009 it’s compulsory)

• Restriction of the asset management fee: The annual fee not allowed to exceed the 0.8% of the size of assets.

• Restriction of the operating expenses: Maximum 5.5% (from 2009: 4.5%) of the membership fee incomes can be spent on operating expenses.

• Apart from 1 year’s yield indexes the last 5 years’ (from 2009: 10 years’) indexes must be published.

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Implementation of multifunds – administrative requirements

• Funds must create exactly 3 portfolios• Classic (law risk and yield)• Balanced (middle risk and yield)• Growth (high risk and yield)

• A member’s saving can only be in one portfolio at the same time• Member’s decision can be

• an own choice• or „auto-enrolment” which means the acceptance of enrolment based on the time

remaining until retirement age (62 years)• If it’s more than 15 years: Growth portfolio• Between 5-15 years: Balanced portfolio• Less than 5 years: Classic portfolio

• Funds must update the automatic enrolment based on time remaining at the end of every year

• Members can change portfolio any time, but not more than with 6 months’ frequency (fee: 1 ‰, max 2,000 HUF)

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Implementation of multifunds – asset management requirements

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Classic Balanced GrowthReal estates 0% MAX 10 % MAX 20%Venture capital funds

0% MAX 3 % MAX 5 %

Derivative funds 0% 0% MAX 5 %Shares MAX 10 % MIN 10 %

MAX 40 %MIN 40 %

The limits ensured necessary scope to create well-diversified portfolios.

Determined optimal investment term• Classic portfolio: short-term liquidity without losses, yield advantage

will have to appear within 5 years• Balanced portfolio: yield advantage will have to appear within 10

years• Growth portfolio: yield advantage will have to appear long term (over

10 years)


Accounting unit based approach

• Earlier: Distribution of yields by average stocks of individual accounts every quarter

• Accounting unit based records system• Account keeping in units primarily• Base exchange rate at the time of starting: 1.000000 HUF/unit• Daily calculation and publishing of exchange rates for all portfolios• Every transaction is converted from HUF to units (and in the opposite direction) by daily

exchange rates• Account balance in HUF: account balance in unit x daily unit exchange rate

• The new method is exact, but labour-intensive: it requires close cooperation of fund, asset management company and custodian every day

• The real challenge - system development and operation - was the change to accounting unit based method (less the multiportfolio system)

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Implementation statistics

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Headcount (person)

Distribution

Classic 208 0,03%

Balanced 53 424 7%

Growth 671 097 93%

Together 724 729 100%

Headcount (person)

Distribution

Classic 3 162 4%

Balanced 17 045 22%

Growth 57 879 74%

Together 78 086 100%

Headcount (person)

Distribution

Classic 52 0,1%

Balanced 8 093 10%

Growth 69 941 90%

Together 78 086 100%

Members who didn't choose portfolio (by

age)

Members who chose portfolio (by

own decision)

Members who chose portfolio (by

age)

• 10 from 18 mandatory pension funds started in 2008

• OTP Mandatory Pension Fund’s data(market share by membership: 30%)

• Almost 10% of membership chose individually

• Most of individual decisions reflected the proper classification by age

• Slight overweighting of Classic portfolio


Adverse returns geared by multifunds

2008: Unfortunate timing of implementationDue to recession and equity market trends in 2008, pension funds applying multifund system have significantly underperformed the funds with single portfolios.

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2008 2009 H1

MAX 2,59% 2,39%

BUX -53,34% 25,15%

CETOP20 (in HUF) -50,22% 5,23%

MSCI Europe -42,39% 5,78%

MSCI World -35,70% 9,38%

MSCI Emerging Markets -49,25% 39,89%

Standard exchange rate index yields

• Significant part of 2008 year’s losses (not realized) till the middle of 2009.

• Difficulties in communication: In the annual statement of account (which was delivered in June 2009) members were facing the losses of 2008


Post implementation experiences I.

Fund members’ reactions to the crisis in regard to OTP Mandatory Fund

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• October 2008: falling of the stock market rates

• February 2009: publishing of the 2008’s yields of pension funds

• End of June 2009: Delivering of the annual statement for members

• 1,554 switching transactions during 20 months (number of members: 800 thousand)

• Members don’t show too much interest in their own pension savings.

Members' switchings between portfolios (Jan 2008 - Aug 2009)

050

100150200250300350400


Post implementation experiences II.

Recommendations (not too much success) to members regarding the portfolio transfers:

• In case of lack of personal knowledge age based classification

• Choose portfolio for long-term• Don’t realize losses by switching to a

less risky portfolio

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Fund members’ reactions to the crisis in regard to OTP Mandatory Fund

Classic Balanced 6

Classic Growth 11

Balanced Classic 131

Balanced Growth 48

Growth Classic 836

Growth Balanced 522

1554Total

Distribution of members' switchings by portfolio types


Post implementation experiences III.

• Agents capitalize the crisis and „convince” the members of usefulness of switching.

• From the 2nd half of 2009 the rules of switching are more rigorous:• Members must declare they had been informed about fund’s yields and risks of switching• Raising of switching fee

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Fund members’ reactions to the crisis in regard to switching between funds (all mandatory sector)

Switching between funds (person)

010 00020 00030 00040 00050 00060 00070 00080 00090 000

100 000

2008 Q1 2008 Q2 2008 Q3 2008 Q4 2009 Q1 2009 Q2(forecast)


Evaluation of the Hungarian multifund system I.

Positives• Stable and useable model was born in a short time which can and must

develop further.• Possibility to create well-diversified investment portfolios.• In this time - in spite of crisis - retiring members are fortunate with the

new system (proportion of the government securities in „Classic” portfolio more than 90% - in single portfolio system it was only 70%)

Negatives• Funds introduce the multiportfolio system at different times:

• Due to crisis those funds which were faster and more client orientated suffered higher losses in 2008.

• Starting dates of daily exhange rates are different at the funds exchange rates of funds are not comparative directly.

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Evaluation of the Hungarian multifund system II.

Need improvement• Duration of portfolios are not optimal for all age-groups

• Duration of the 3 portfolios is not designed to match short-term savings (especially within 2 years before retirement) or the needs of career-starters (over up to 45 years)

• Switching portfolios may lead to losses• The law requires to allocate participants to the matching portfolio as of the end

of the year, regardless of the costs and losses caused by this forced switching.

• Participants are not encouraged to take advantage of diversification• Many of the participants are likely to stick to the portfolio they are allocated to.• Limited opportunities for the individual to allow optimal asset-liability matching.

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Multifunds system – an alternative approach I.

„Target date (lifetime) funds” system Intention: To avoid the double traps of taking low risk at young age and high

risk at old age• Creating the portfolios and classifying the members on the basis of age,

also.• But: If the member dosn’t choose individually, will stay in the same

portfolio until retirement.• Portfolios have life-cycle periods and maturity.• Number of portfolios is fixed. If a portfolio runs out, another takes the

place of it, and the new portfolio will be the longest maturity.• In the portfolios - in their duration - proportion of high risk assets

continuously decreases.

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„Target date (lifetime) funds” system

Alternative assets

Shares

Government securities

Money Market

Time turn of the asset allocation from working age (around 25 years) to retirement (65 years)

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„Target date (lifetime) funds” system - An example from USA

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Multifunds system - Conclusions

Key issues• Timing• Education of membership: Financial awareness ( Risk ↔ Yield)• Number of portfolios: Should be optimal for all age-groups• Investment policy: Enough room for diversification

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18 September 2009, Sofia, Bulgaria

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