The island of freedom

Dmitriy Karpov

The pension system faces two types of clients

Enough inertia exists even within the Kazakhstani pension system, which is seemingly facing serious changes. Those forthcoming alterations cannot be irrevocably defined as a revolution from above. On the contrary, such transformations are taking place without the participation of regulators. One way or another, all existing expectations will come into being, and the result will be a significantly more dynamic market, providing choices for the two primary client types – conservative and risk-seeking – with a greater differentiation between the funds.

The first of such vital changes from of above has been the adoption of new rules, as of July 1st, according to which the transfer of pension contributions is carried out not through the pension funds themselves, but by the State Center for Pension Payment (SCPP). The opinion is that such a move will greatly lower the possibility that employers and accounts will influence the choice [of pension funds] of employees. Before, a firm excuse existed in forming solidarity, so that an accounting department would not have to make payments to several funds each month, which could, theoretically, mean transfers to all 14 registered pension funds. So far, the pension market has been controlled by employers, and not by the two client types. Even if funds position themselves as retail institutions exclusively, in reality one of the defining factors in directing pension assets remains the loyalty of entrepreneurs and directors to certain financial groups. Stimulating the pension funds to achieve the highest rate of profitability in relation to the [associated] risks, or increasing the level of service, has not been sufficiently defined. How fast changes to the system can be made is hard to say, as well as when such new opportunities for future pensioners can be realized. The data for July has already been published, and as expected no serious changes have occurred thus far.
The second factor speaking of far ranging changes is the more actively discussed intention by the Financial Supervisory Agency (FSA) to control the investment planning of pension funds, which would be more or less aggressive [than currently]. In this stage of the discussion, many consider that there will be several portfolios within each fund, such as a conservative variant, with a significant portion of investment into government securities, a less conservative alternative, and a risky one. Although, investment into corporate securities as part of the last option will be dependent upon a company possessing a rating of not lower than BB, which is currently only held by the three largest Kazakhstani banks, state-owned companies, and development institutions. The choice of portfolio will be according to the free will of the two client types, with the only restriction being that in the last five years prior to retirement they would not be able to choose the risky variant. This three-tier model is based on the Chilean system, which still remains a touchstone for us, and where a system with five alternatives was established in 2002. One of the questions relating to the issue of multiple portfolio options is whether the state should guarantee the level of return on funds accumulated in pension accounts at not less than the then current rate of inflation during retirement. The prevalent position is that such guarantees should be in place for both types of clients and across all portfolios. However, possibly it would be more logical to apply the guarantee only to those who had chosen the conservative portfolio variants, which mainly involve the purchase of government securities that provide a lower yield. The argument in favor of guarantees to both types of clients is that all citizens are similarly important for the nation, including those who are locked into riskier portfolios.
The creation of a portfolio begins with a wish to follow the Chilean model, offering a wide range of choices to the two client types, apparently is associated with the development of the market. This year, a very clear differentiation in profitability among funds has started to develop, a stage that should have come under the portfolio system. National Pension Fund Bank TuranAlem Kazakhstan (NPF BTA) and the State Accumulative Pension Fund (SAPF) have become the two primary suppliers on the market. Despite market corrections in the share price during June, BTA Kazakhstan, the parent financial institution of BTA, has maintained a high level of returns (for the last three years, this has averaged above 68% annually). Considering that over the last three years the average weighted coefficient (24.12%) of all pension funds has not been able to outpace inflation during the same period, the phenomenal profitability demonstrated by BTA is a serious challenge to the market. Many consider that this is primarily related to large investments into shares of Kazakhstani companies during the course of this significant growth. Although, this extraordinary growth rate cannot be explained purely by the stated strategy, as yields on non-governmental, tenge-denominated securities have not been the highest on the market. Nonetheless, the nearest competitor has returns approximately three times less than BTA. Probably, such a situation could not exist in a normal, healthy market, as other funds should have radically changed their investment strategies, or spoken up about the risks that are forbidden them, putting such investments in doubt. In the July summary, stock analysts noted, following market corrections, a certain growth in investment into Kazakhstani shares. However, this permits discussion of a serious trend, as the portion of shares included into pension portfolios increased only up to 12.22%, up from 12.06% in the month before. The market share of BTA (9.12%), despite the organization’s high profitability, is rising very slowly, leaving it far behind the three market leaders.
SAPF remains the most conservative on the market, and for the past few years has been conscientiously building its investment portfolio, while considering its long-term forex position, including [investment into] instruments denominated in foreign currencies, against the backdrop of a strengthening tenge. The significantly drawn-out pre-privatization period, along with the absence of any arrangement among operators on the grounds of returns or market share, are issues with which SAPF has not had to struggle. This has permitted the management to become peculiar artists, building the most by-the-book portfolio, with balanced risk. The main question between SAPF and BTA is how much realization the two types of clients will have concerning their choices. Apparently, changes related to differentiation within portfolios will not soon occur. The possibility of choosing funds without interference by the accounting office will give an idea to future pensioners about real investment options.
If the high profitability of BTA is maintained for a somewhat long period of time, it may apparently become the object for complaints by other funds due to a deficit in investment instruments. Although, such a development is not very possible. Returns on investment lower than the inflation rate within the pension system as a whole remains an embarrassment to fund managers and the authorities charged with overseeing the system. Fundamental steps can be taken in the forthcoming months if small blocks of state-owned companies are floated on the market, and above all made available to pension funds and institutional investors. A list of the very assets – Kazakhtelecom and Temir Zholy, not including its [strategically important] rail lines themselves – appears not all too impressive, considering that the matter only goes to show the shortage of available instruments. This damages the interests of practically the entire working population of the country, including the future of the Kazakhstani stock market.
Depending on to what degree the pension system will change, and how the principle of free choice will be embraced by the two client types, the interest of financial analysts and social psychologists may be engaged. Despite the fact that pension reform has been one of the most difficult, and yet successful, of the structural improvements, not much trust for the mechanism of pension payments has been established, and everything occurring is perceived more as an abstraction, rather than anything related to the interests of the people. Apparently, despite very serious criticism, by Kazakhstani measurements, related to the shortage of investment instruments, the profitability of pension portfolios has not been a hot topic. Pressure related to the introduction of new instruments available to pension funds, and the simultaneous development of the Kazakhstan Stock Exchange (KASE), require not such a large client base, but instead the participation of professionals within this market. A certain recovery for the market may not be related to the two types of clients switching between funds, based differentiation of the available portfolios, but, alternatively, in the growth of public interest in reforming the pension system, as otherwise the situation will remain stagnant.