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The Ministry of Finance has sent out for coordination changes to the second pillar of pension aimed at motivating fund managers to earn more money for future pensioners.

The amendment will cut management fees and tie those of more active funds to results. In other words: pension funds will qualify for performance pay. Changes will abolish restrictions on buying shares and allow funds that invest 100 percent of assets is shares. Pension funds will also be allowed to invest up to 10 percent of assets in unrated bonds.

“Funds will get to invest more heavily in real estate and make other non-market and less liquid investments that fit pension funds’ portfolios considering their long temporal horizon. It is expected to support investments in Estonia,” explained Tõnu Lillelaid from the ministry’s insurance policy department.

The average management fee will fall from 0.96 percent to 0.62 percent in 2019. Fees will continue to fall, depending on pension fund volumes.

“I believe that laxer investment restrictions and the abolition of the obligation to invest in bonds come at the right time, considering the high price and low productivity of bonds, and make it possible for funds to show better productivity,” Lillelaid said.

Funds in favor

Founder of LHV and head of the bank’s pension funds Andres Viisemann said that while proposals to amend include debatable aspects, they constitute a step in the right direction. “It is a highly influential amendment that will heavily affect how and where pension funds will invest in the future,” he said.

Viisemann said that the amendments, if passed, will have considerable effect and will cause LHV to thoroughly reorganize its investment activity. That said, he also perceives dangers.

“I hope that changes in question – slashed management fees and performance pay – will motivate fund managers to invest in their teams to achieve better productivity for clients,” Viisemann said.

“There is, however, the danger some banks (asset managers) will opt for cutting costs and halting development, moving investment decisions to their headquarters abroad or opting for direct or indirect indexation as slashed management fees might not cover current level of organizational expenses.”

CEO of Swedbank Investment Funds Kristjan Tamla said that productivity is paramount when talking about pension funds. “Share investments have traditionally played an important part in long-term productivity of funds – stock markets have shown better long-period productivity than other financial markets,” he explained.

Tamla added that considering the long horizon of pension investments, relative importance of share investments Estonian funds have been allowed to maintain has been low. “The ceiling stood at 50 percent until 2010 and has remained at 75 percent since then. For example, pension funds are allowed to invest more than 100 percent of assets in shares in Sweden,” he said.

He does not support the practice of going above 100 percent, however, as the manager’s safety net might not be sufficient to mitigate risks.

Entry into force next year
Tamla regards lower fees as natural development. “It is only natural that growth of pension funds and a more effective system result is lower fees. The connection between the size of the pension system and management fees is very strong in OECD countries – larger funds mean lower fees. The new law would make average management fees in Estonia equal the so-called OECD average.

Head of Swedbank’s funds added that talking about an average management fee in Estonia is somewhat misleading as all manner of statistical averages tend to be. “Only the fees of Swedbank and Tuleva are lower than the national average today,” he pointed out.

Head of Tuleva pension funds Tõnu Pekk also welcomed the initiative. “The entry into force of the new law will cut Estonian management fees by a third. This means that people get to keep an additional €15 million a year,” he said.

Pekk said that the law already requires fund managers to act in the interests of unit-holders.

“Seeing as that requirement has not motivated fund managers to seek better productivity so far, I doubt the amendment will be enough and believe the financial inspectorate will have to take steps to remind managers of their obligation,” he said. “It is certain that lower fees will improve productivity of Estonian pension funds: the millions of euros people get to keep will earn us income in the coming decades.”

The law will enter into force in January of 2019 if passed. Performance pay is allowed starting from 2020 in cases where the previous year’s results warrant it.

Harry Tuul
BNS-i ja Postimehe majandustoimetuse juht