Former Hansapank CEO Indrek Neivelt: Take your pensions to mutual funds
The government deserves credit for its changes to the second pillar of Estonia's funded pensions system, entrepreneur Indrek Neivelt writes in an opinion piece for ERR. With the exception of Tuleva, a mutual fund owned by its contributors, Estonia's funds skim stellar fees and produce very low returns. In Neivelt's opinion, none of Estonia's earlier governments or officials stood up for the interests of those paying money into the funds.
The introduction of the bill reminds me of an expression that became famous in the time of the debt crisis: 'Too little too late.' The fees of our pension funds have been too high for at least 10 years, and the principal thinking behind their investment strategies too rigid. We have built a very clumsy system, changes to which take a lot of time and resources. The Ministry of Finance is forever looking for compromise between the fund managers and the contributors, and this is taking a lot of time.
It seems we have forgotten that it is the job of the managers of the pension funds to work in the interest of the contributors. That is where the real issue is today, that several funds are working in the interest of their shareholders, not the contributors to the funds. And some of the funds aren't even trying to hide this anymore.
How did we end up here?
In my opinion, the main reason is that in 20 years no one has stood up for the interests of the contributors. No politician, no official. The direction taken two decades ago haven't taken reality into account in at least 10 years. The current system benefits only the fund managers' short-term interests, and nobody has tried to change it. Or, more specifically put, nobody has held against the fund managers. And if it hadn't been for the arrival of Tuleva in the market (Estonia's only mutual pension fund; ed.), the topic would not even have come up.
The roots of the problem go deep. Our system was built on the principle that there are contributors and there are fund managers, and in between them as a check is the state, or in other words ministers and officials. They are the ones who have to try and find a compromise and work out legislation the implementation of which is then in turn checked by the Financial Supervision Authority (FSA).
This is a complicated, clumsy and expensive system. But we could do it differently as well, namely in such a way that the fund managers work in the interest of the contributors without constantly needing to be reminded what their job is.
Take Finland, for example. Let's compare the performance of Varma and Ilmarinen, two large Finnish pension funds, with that of Estonia's funds:
Productivity of pension funds in percent per year (sources: Varma and Ilmarinen annual reports, Ministry of Finance):
As you can see, our results are far from competitive. If administrating pension funds was a sport, there wouldn't be any other where Finland is beating Estonia as badly as in this one.
And there is really no reason why it should be this way. The euro is in use on both sides of the Gulf of Finland, and both sides are free to invest anywhere in the world. At the same time, the Finns have invested a whole lot more in their own economy, and have contributed to it this way. Which means that their funds' influence is more positive than that of ours.
So where is the big difference?
First off, there is the distribution of funds. Our funds invest more than 60% of their money in low-yield assets, eg in bonds. In Finland, this share is significantly smaller, and more importance is assigned to stocks. And that in a situation where the Finnish pension funds actually pay out pensions, too, and not only collect them.
The distribution of our assets dates back to the early years, when people had just three types of funds to choose from. And going from there, what people have done is to simply collect funds passively, and the fund managers have invested them. Our money is just sitting there in low-yield foreign bonds—instead of eg being invested in local real estate.
To illustrate this point: while our pension funds are tied up in Italian and Spanish bonds and produce returns at a fraction of a percent, the Italians and the Spanish are buying Estonian real estate and having us pay rent. The same investors beyond their 6-7% return on real estate also get to pick up cheap loans here, which boosts their returns to well over 10% per year. And all of this is happening and has been happening right before our eyes for quite some time, and everybody seems to be happy with it.
We are happy saving money for our pensions, and the foreigners are happy earning 10% return on investment a year. And on top of that, foreign investors have been given preference over domestic ones from the beginning.
The new law will bring a few improvements in this area.
The second difference between Finland and Estonia is the contributors' awareness of ownership and understanding that a fund should be working to the benefit of the contributor, not its manager.
If for example one of our own funds invests in real estate, then it doesn't do it directly, but through other funds. In Finland, the pension funds own plenty of real estate directly, and they maintain it themselves as well. They are doing this at low cost. We on the other hand have stakes in real estate funds that by themselves ramp up costs, and who also want to earn a profit. The result of this is that eg with Ilmarinen in Finland, a pension fund contributor spends ten times (!) less on real estate costs than we do.
The Finnish system works in the interest of the contributor. The contributors are in charge. And that's how simple it is.
The third big difference is in the fees. In Estonia they are plainly too high and have not corresponded to market conditions for a long time. Had the fund managers acted in the interest of the contributors, they could have simply placed the money in similar funds of their parent bank, and the fees would have been several times lower. Or they could have bought index funds and kept costs low.
But in that case, the banks would have made less money. And as I said earlier, nobody has stood up for the interests of the contributors in 20 years. Only over the past two years Tuleva has tried to do this with the little means it has available.
So what can we do?
With the government's bill we are basically moving in the right direction. But still not boldly enough. The fund managers should be given a lot more freedom, and the principle of the three different types of funds should be abandoned. Every fund manager should have just one, and the objective of that fund should be to run at maximum productivity.
With fewer different funds, public interest in the content of their portfolio and their results would be greater. Right now, there are too many funds, and distinguishing between them is difficult. And all of these small funds cost a lot to maintain. So all that is left to do is to choose from among fund managers, not types of funds.
Greater freedom for funds to invest solves a big problem. Fees would likely drop as well. But the conflict between the fund manager and the contributor still remains… The fund manager will still go on working towards a maximum fee. Productivity will influence this to some extent, but sooner or later this will need addressing as well.
All in all, our current system isn't self-regulating. It needs constant interference by the state. What we need is a self-regulating system where the contributors are responsible. Collecting funded pensions wouldn't be up to the government anymore, but in the responsibility of every individual contributor. The experience of the last 20 years clearly shows that neither our government officials nor our politicians are strong enough to defend the contributors' interests.
Ideally, pension funds would belong to the contributors. Just like Tuleva belongs to its contributors, not to a third person. This would mean that the contributors themselves control the fees, and that the fund would spend just what is necessary. The contributors would also be responsible for the share of assets in real estate, stocks or bonds. In today's system, it is very difficult to decide what the right formula behind a fee should be, and it shouldn't be decided by 101 people on Tallinn's Toompea Hill (ie the Riigikogu; ed.). The system should regulate itself.
Today we have €4 billion in our pension funds. Had the funds been run in the interest of the contributors and not their managers, this would be at least €5 billion by now. Which means all of us have lost out on money in the amount of a quarter of what is there.
The new law is a push in the right direction, but an even better solution would be if we had three or four mutual pension funds. In other words, it would do as all good if there would me more mutual funds, and if people stood up to the managers of the existing private ones. Only then would we have a self-regulating system.
Editor: Dario Cavegn