Our yields are below inflation

Interview with Vnesheconombank’s Trust Management Department Director Alexandr Popov

Last year more than a million “undecideds” transferred their pension savings to trust management companies and non-government pension funds. One of the reasons for it were low yield rates of the State Trust Management Company Vnesheconombank, which failed to exceed inflation rate in 2006. Yet, in the opinion of Vnesheconombank’s Trust Management Department Director Alexandr Popov this fact does not testify to the State Trust Management Company’s inefficiency. The problem is that VEB does not have instruments that can allow it to diversify its pension savings portfolio and hedge pension funds against inflation. ALEXANDR POPOV told RBC daily observer ALBERT KOSHKAROV about instruments in which VEB is prepared to invest pension funds.

- Why did VEB offer to expand a list of instruments in which it can invest pension savings funds? Will it really help to hedge pension funds against inflation?

- We made this offer as early as 2003 when it was obvious that the conditions laid down by lawmakers for the State Trust Management Company prevented it from fulfilling its main objective of protecting pension savings. It was clear that given low government securities yields, which were and remain to be the only instruments available to the State Trust Management Company for investing pension savings funds we wold not beat inflation. Furthermore, budget revenues were on the rise and MinFin’s need for new borrowings declined. The year 2004 demonstrated all this vividly. In fact, in 2004 we could invest pension savings funds only in OFZs because all transactions in pension savings funds were to be conducted on the stock exchange. And eurobonds were not are not traded on the stock exchange. So we failed to generate high yields using only one instrument. But in 2005, when we were allowed to conduct transactions in eurobonds, we performed rather well: the dollar was more or less stable and it even rallied against the ruble and that was why we managed to generate high yields and beat inflation. Besides, prices for OFZs soared. But the situation changed in 2006. The ruble rose a lot more rapidly and as it was not possible to insure currency risks, the value of eurobond portfolio lowered.

- What is the structure of VEB’s pension funds investment portfolio?

- By law, we are allowed to invest in four types of assets: ruble-denominated government bonds, currency-denominated government bonds, Russian mortgage bonds, guaranteed by the state and balances of trust management accounts. By the way, until March this year the maximum share of investments in ruble-denominated bonds was 80%. But there are no and there will be no government-backed mortgage bonds in the market that is why we invest pension funds in OFZs and government savings bonds, which are pretty attractive to long-term investors. As far as currency-denominated bonds are concerned, the situation here is more complicated as their exposure to currency risk is rather high as the ruble strengthens. But until March this year we were not able to reduce this position because, given the maximum share of ruble-denominated government bonds at a level of 80% and monetary funds at a level of 20%, we should have a cushion. The only instruments available for such a cushion are eurobonds. Last year we invested in them about 6- 7%. Their presence in the portfolio last year was one of the reasons why the State Trust Management Company failed to generate higher yields.

- Did last year’s dollar fall against the ruble eat up the entire income?

-Yes, in fact, currency revaluation ate up the entire coupon yield and these securities’ (eurobonds’) value gain. So we failed to generate sufficient yield, on these instruments, on the contrary we lost. Undoubtedly, if we had been legislatively permitted to insure currency risks the situation would have been more favorable. In March this year the Government lifted restrictions on investments in ruble-denominated securities, so the share of eurobonds in the portfolio will shrink and among other things it will also fall through receiving new pension funds. If we had been allowed we would have withdrawn from eurobonds as early as last year. Furthermore, yields were affected negatively by the fact that we had huge balances of uninvested funds because to invest in eurobonds with currency risk last year meant to be doomed to failure. No interest is charged on balances of accounts with the Central Bank where we keep rubles. So about 14% of funds were kept in accounts without generating any profit.

- What do you think of the idea to invest pension funds in foreign assets in order to reduce MinFin’s annual amount of borrowings?

-It is a difficult question because as opposed to the Stabilization Fund, which is not to be invested in Russia, pension savings funds are different by their nature. In fact, they are generated by the Russian domestic economy and they are part of Russian citizens’ wages received in the form of taxes and their investing inside Russia does not have any inflationary effect. On the contrary, this money can be successfully invested inside Russia. Basically, we can’t rule out the possibility of investing them in some currency-denominated instruments, particularly, in synthetics with capital guarantee but this should be done in line with general strategy over periods of potential growth in rates and increased yields of western financial instruments as compared to Russian ones.

- But if you keep on investing pension funds worth billions of rubles, won’t it bring about a liquidity crisis?

- There isn’t and there won’t be any serious problem here. Excessive liquidity exists in the country but this phenomenon will be short-lived. Now the inflow of money is a result of several developments, specifically, state banks’ IPOs and SPOs and the YUKOS auctions. But in the future there will be no excessive liquidity in the Russian market, the normally developing economy is capable of handling a large amount of funds. And if we assume that the pension funds of “undecideds” (now they amount to about 80-100 billion rubles a year) could have any impact on the markets, this sort of assumption, given the current market volumes, is ungrounded. Now VEB’s share is only 0.14- 017% of the whole issuer’s securities turnover. So even if the State Trust Management Company’s stock exchange transactions increase threefold or fourfold we won’t be among the first thirty largest players. By comparison, I would like to say that that Troika Dialog’s turnover of issuer’s securities is steadily in excess of 1 trillion rubles per one quarter.

- Are you interested in mortgage bonds?

- There is no doubt that mortgage bonds are the most interesting securities as they are secured by a pledge. They do not require government guarantees. But so far there haven’t been any large issues of mortgage bonds except for the issue floated by “Gazprombank-Ipoteka” and the first issue floated by the Mortgage Housing Lending Agency. It was not until recently that it has become possible for issuers to issue ruble-denominated bonds and it would be wrong to expect banks to start issuing mortgage bonds worth tens of billions of rubles. According to experts’ projections, mortgage securities worth 30 billion rubles are expected to be issued till the year-end.

- Taking into account that now VEB has more than 260 billion rubles in its accounts, the said amount is not very large.

- This amount is even less if you take into consideration legislative restrictions. According to the Russian laws, the State Trust Management Company is permitted to purchase no more than 35% of one issue. Yet, this year we could as well invest a large amount in mortgage bond, as early as this year. Of course we have to assess the credit quality of each such issue and quality of a pledge and besides we still have an unsolved problem of enforcing a pledge.

- Can the State Trust Management Company get new instruments for investing pension funds as a result of reorganizing VEB into a Development Bank? For example, in some government departments they say that pension funds could be invested in long-term government projects.

- I don’t think that this is possible as pension money is, in fact, separated from Vnesheconombank’s own funds by the Chinese Wall. Furthermore, direct lending of funds received to be held in trust management is banned by the Civil Code. So, in view of the fact that VEB is being transformed into a Development Bank we believe it would be worthwhile to invest in the bonds of companies involved in carrying out major government projects, perhaps, with the participation of the Development Bank. Of course, yields of such instruments can be hardly compared to profits from commercial projects, nevertheless, they are stable and long-term. But the Development Bank’s participation its expert and control potential can additionally guarantee repayability and profitability of such investments.

- Do you regard Russian companies’ shares as a possible instrument for investing pension funds or do you prefer to invest them in bonds?

- We don’t think we should invest in shares because we give high priority to protecting pension funds rather than making money in the stock market. The State Trust Management Company should remain a conservative investor, with its strategy aimed at generating stable yields. Shares are exposed to greater risks and, in our opinion; even in case of purchasing blue chips risks are rather high, as have shown the latest developments in the stock market. While our yields are now below inflation, they are pretty stable and do not depend very much on market fluctuations.

- Now the future of the pension reform is being extensively debated. How do you size up the development of the private pension insurance market? Why do most people remain to be “undecideds”?

Generally speaking, it’s too early to appraise the pension reform; the fact is that it is designed to be implemented for a long period of time. It is not until 2022 that we can see the real effect of investing the funded portion of pensions. To our mind, the only problem is that during all these years the reform has been developing in a near-total information vacuum. It is not until this year that the Government has approved a program designed to raise public financial awareness. Nevertheless, we can see the first results of the reform. For example, in early 2004 the State Trust Management Company’s share in the pension funds market was in excess of 98% but now it has shrunk to 90%. In this year’s first quarter, the number of applications submitted to the Russian Pension Fund for transferring the funded portion from the State Trust Management Company tripled from last year’s first quarter. This means that more people are moving to the private sector. 

- What do you think of some senior officials’ proposals to give “undecideds a deadline for making a choice between the Russian Pension Fund and non-government pension funds? Will this boost the private pension insurance market?

- I think that it would be wrong to give “undecideds” a deadline. There are always people who are reluctant to make a choice. And it would be inappropriate to deprive them of their right to savings already made. Russian citizens have just begun to move to the private sector. In our opinion, these proposals are nothing but an attempt to solve the Pension Fund’s deficit problem and they do not help to develop the mandatory funded pension system.

- There is another way, for example, you can transfer a part of funds under VEB’s trust management to private trust management companies in order to increase pension funds’ profitability.

- Is there any sense in doing it? The fact is that investment yields do not depend on the number of trust management companies, they depend on a range of investment instruments and portfolio diversification level. In the case that they permit it to invest undecideds’ funds in the same range of instruments which is now accessible to private trust management companies, investment risks would increase manifold and if the Russian stock market keeps on growing rapidly, none of “undecideds”will move to the private sector thus delivering substantial blow to non-government pension funds’ client base, But if we somewhat expand the range of investment instruments while maintaining it conservative then it does not matter if there will one or ten companies responsible for investing undecideds’ funds. There is no doubt that these companies will go into some sort of competition but in this case competition will be harmful, because we can’t rule out the possibility that in their pursuit of higher yields trust management companies will seek to invest funds in more risky instruments.

- But if you just expand a list of authorized instruments for the State Trust Management Company, a powerful monopolist will enter the market.

- I’ve already said that taking into account the current financial market volume, the State Trust Management Company won’t be able to monopolize the market with pension funds. This argument could be considered relevant in 2005, when the idea to allow private trust management companies to manage udecideds’ funds emerged. Monopolization potential was regarded as the only reason not to allow the State Trust Management Company to invest in corporate bonds. But at that time neither regulators nor we could foresee that financial markets volumes would grow as rapidly as they have in the previous two years. In our opinion, we face a different kind of danger now. The largest private trust management companies will seek to participate in managing undecideds’ funds. According to the Federal Service for Financial Markets, in this year’s first quarter the largest four companies were in control of over 25% of issuer’s securities turnover and 14 organizations accounted for 50% of the turnover. Hence, participation in managing undecideds’ funds would only increase the largest private companies’ market share and this  would encourage monopolization.

RBC daily, 04.06.2007