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Magazine Issues » May 2011

LOCAL MARKETS: Domestic bliss

Local_marketsStability has returned to the CEE region which endured a panic effect in the wake of the financial crisis and had to rebuild confidence in investment in the aftermath of the fall of communism. Fiona Rintoul reports

The central and eastern European (CEE) economies, in broad terms, were in better shape than their western European counterparts when the global financial crisis hit. But the region’s funds industries nonetheless suffered a serious set-back in the wake of the crisis as local stock markets went into free fall and investors withdrew from funds.

In fact, the “panic” effect was perhaps more keenly felt in the CEE region than elsewhere in Europe, as in some countries confidence in investment products had needed to be painstakingly rebuilt in the wake of pyramid-selling scandals in the immediate aftermath of the collapse of communism. A further problem was the double-digit returns, which preceded the crisis, the possibly transitory nature of which was not always properly understood by investors – or properly explained by advisers.

Money market funds, in particular, were being used by some investors as savings accounts with better performance. The idea that these funds could be volatile came as a shock to many when the crisis hit. The result was a flight to safety, with investors in many countries favouring capital-guaranteed products or turning away from investment funds altogether.

In the meantime, the situation has stabilised. Most of the CEE markets saw their assets under management (AuM) increase strongly in 2010. In Poland, the largest CEE market within the European
Union, AuM rose by 21.2% in 2010, while the Czech Republic and Hungary saw more muted growth of 9.8% and 12% respectively, and the fledgling market of Romania saw its assets rise 62.7%. Additionally, all the CEE markets tracked by the European Fund and Asset Management Association (Efama) experienced strong inflows in 2010 (see table, page 14).

As the table shows, the asset classes that appealed most to CEE investors in 2010 varied greatly. In Hungary and Romania, money market funds saw the strongest inflows, while in Poland inflows were spilt
fairly evenly between bond and money market funds. In the Czech Republic, investors favoured bonds and, in Slovenia, equity funds took centre stage.

These variations can partly be explained by transitory factors, such as prevailing interest rates of 9% in Romania, and partly by long-standing differences in risk appetite.

“The core products are still quite conservative in specific countries, such as Slovakia, the Czech Republic and Romania,” says Christa Bernbacher, managing director of Raiffeisen International Fund Advisory.
“Russia, Bulgaria and Slovenia, who are risktakers, have been investing in equities.”

The global financial crisis has not changed these basic divides, which Bernbacher ascribes to some countries being crisishardened due to past experiences. For example Russia, no stranger to financial ups
and downs, or Serbia, where a financial crisis does not count as a crisis at all. The conservative countries are still interested in capital-guaranteed products, she says, while the risk-takers can be tempted by
commodities funds, Russian equity funds or emerging-markets products.

What perhaps has changed is the desire for clear information on the part of investors in the CEE region. There was much criticism of the standard of financial advice in the region in the post-crisis period, and for
many CEE investors, the crisis constituted a wake-up call with regard to the advice they had received.

“The financial crisis has changed the asset management industry as well as its products towards the more simple and easy-tounderstand,” says Filip Jokeš, finance and reporting officer – central Europe at
KBC Asset Management. “Products need to have clear information and also the underlying assets have to be easy to understand for the customer.”

The focus on domestic products that was a feature of the boom years, when the CEE stock markets were providing doubledigit returns, also persists. Hopedfor reforms on the pensions side that would allow pension funds to invest a greater proportion of their portfolio in international assets have not materialised. But again there is variation from country to country in terms of how domestically focused investors are.

“It depends on the size of the country,” says Werner Kretschmer, chief executive officer of Pioneer Investments Austria and head of CEE. “A small country such as Slovenia is more open, but then investors
focus on the CEE region. They believe in their region.”

Another reason to stick with domestic products is currency risk. The desire for products denominated in local currency also has an impact on the opportunities that exist to distribute funds cross-border in the region. In many countries, most investors will not accept a product denominated in euros, though there are exceptions.

“Countries from the former Yugoslavia are more open to euro-denominated products because they always had a close relationship to the Deutschmark,” says Bernbacher.

As far as the thorny issue of advice goes, there has, most commentators agree, been a considerable improvement in standards in the region in recent years. The catalyst for this does not seem to have been
an expansion of the independent advice sector, as some observers had been predicting a couple of years ago. Indeed, standards in the small independent sector do not appear to have exceeded those in the
banking sector.

“Independent advisers have been selling funds in the CEE countries from the beginning without much regulation by the authorities of their communication with clients,” says Jokeš. “Market contractions have demonstrated that mis-selling through independent advisers has been rather common.”

The impetus for change has rather come from EU-level regulatory initiatives, principally MiFID (Markets in Financial Instruments Directive). Such initiatives have motivated the banks, which remain the primary distribution channel for investment funds in the region, to up their game.

“Banks have put a lot of effort into systems, training, improving service and finding the best approach for clients’ needs,” says Bernbacher. “They’ve also put a lot of effort into educating advisers.”

But again, there is considerable variation from country to country. “If you look at the CEE region, the countries are at different stages of development,” says Kretschmer. “Whereas the Czech Republic and
Poland are very developed and close to the situation in western Europe, that’s not the case in, say, Romania. You need to take that into account.”

On the institutional side, however, there is still much to be done. Cronyism, corruption and unimaginative investment choices characterise the landscape.

“RFPs [request for proposals] are hardly known in the CEE countries,” says Bernbacher. “We are waiting for that to come to the market.”

The institutional business in the CEE countries remains somewhat thwarted by governments’ failure to improve pensions legislation. Jokeš notes that in the Czech Republic there has been an ongoing political
debate for ten years about changing the pensions system. At the moment, pension funds cannot make a loss in any given year, so all assets are allocated to very safe securities, usually government bonds.

“In reality, the pension funds are not used as an effective tool to secure financial comfort for seniors, but as a kind of advantageous saving with the state providing the subsidy,” he says. “The volume of clients is high but the volume of invested money is low. Reform is really needed here.”

Meanwhile in Hungary, the government has nationalised private pension funds to drum up resources for the state pension system. “We see this as a step back to pre-1997 reform,” says Jokeš.

The prospects for reform of the pension systems in CEE do not at the moment look especially bright – with the exception of the Czech Republic, where some believe reform may come soon. What looks much more promising, as the economies of these countries are generally in good shape with reasonably strong GDP growth and fewer debt problems than their western European counterparts, is the retail market.

“We are fairly positive about CEE,” says Bernbacher. “Western Europe is doing quite well, especially Germany and Austria, and this brings positive stimulus to CEE.”

Bernbacher says a doubling of AuM over the next three years is not out of the question. And with the advent of Ucits IV it should become easier to sell a much wider range of products in the region. The
master-feeder structure means that it will be easier to create local currency versions of funds and that it will be possible to offer funds in a given market even if the AuM expected from that market is not especially high.

“We expect an increase in funds under management, also a change in the asset allocation towards mixed products and equity, and increasing knowledge of the population regarding investment products,” says Jokeš.

“We see many opportunities for cross-border activities in the future, especially with the upcoming Ucits IV legislation.”

©2011 funds europe