Voluntary Pension System VPS

1
Voluntary Pension System (VPS)

• A critique on the Investment Policy
• Najam Ali
• CEO ABAMCO Limited

2
Presentation Overview

• VPS Structure
• Sub-Funds
• VPS Asset Allocation
• Investment Process
• Critique on Asset Allocation Requirements
• Investor Goals and Constraints
• International Comparison
• Prudent Person Rule versus New Prudent Investor
  Rule
• Qualitative versus Quantitative Diversification
• VPS Investment Limits
• Critique on regulations
• VPS A long way to go

3
VPS The Structure

• The Voluntary Pension System a
  self-contributory pensions savings scheme
• No restriction on the employer to join in and
  contribute to its employees pension
• Max contribution limit of PkR 500,000 p.a. by any
  individual
• Relaxation for participants joining the pension
  plan after the age of 41
• Allowed an additional contribution of 2 p.a.
• Total contribution must not exceed 50 of the
  individuals total taxable income

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VPS Sub-Funds

• VPS a scheme with three sub-funds
• Equity Sub-Fund
• Debt Sub-Fund
• Money-market Sub-Fund
• Additional classes such as real estate and
  international investments may be added later
• Asset allocation as per participants return
  objectives and levels of risk aversion

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VPS Asset Allocation

• Pension fund managers (PFMs) to invest with
• Transparency
• Efficacy
• Prudence
• Soundness
• PFMs to offer at least 4 pre-set asset allocation
  schemes

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VPS Investment Process of an IPA
Part 1 Formation of an Investment Policy
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VPS Investment Process of an IPA
Part 2 Monthly Fund Flow
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VPS Critique on Asset Allocation

• Potential inefficiencies due to overly structured
  asset allocation
• Structured asset allocation schemes may not be
  applicable to all investors
• An individuals position in a defined asset
  allocation scheme may hamper his/her investments
  from growing at competitive and efficient rates
• Limitation of only one change per year in the
  percentage of contribution to each sub-fund is
  too restrictive as investor preferences,
  abilities and characteristics are dynamic so
  should the asset allocation
• Recommendations
• The limit on rebalancing and switching between
  investment classes should be increased to twice a
  year
• Rather than defined allocation schemes, each
  IPAs investment policy should be in accordance
  with the participants characteristics
• Investors should have the flexibility to invest
  any fraction in a particular class for example
  100 in equities

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VPS Critique on Asset Allocation

• Recommendations (cont.)
• Investments should be made on principles of
  diversification, maximizing returns to
  participants and limiting risk
• Investors objectives and constraints should be
  evaluated before formulating the investment
  policy (unlike predetermined allocation)
• Product differentiation should be encouraged
  else
• All PFMs follow similar investment objectives
• Higher marketing and administrative costs
• Investment managers should be given more autonomy
  and flexibility to evaluate an investors risk
  level and use their prudent judgment in devising
  the optimal investment policy

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VPS Investor Goals Constraints

• A common global practice To evaluate investor
  goals and constraints before formulating an
  investment policy a law in UK
• Appraisal forms to judge the willingness and
  ability of the investor to take risk
• Rule of thumb Go by the willingness to take
  risk, unless the ability is less than the
  willingness
• Asset Managers (are sometimes required by law) to
  only offer those investment opportunities to the
  investor, which are in line with their risk
  aversion level
• Fallbacks in the VPS Rules
• No requirement to evaluate investor objectives
• Allows investors to make decision and choose
  scheme
• Or if no decision by investor assign to
  Conservative or Very Conservative scheme
  possibly inefficient
• May not maximize investors utility

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VPS Investor Goals Constraints

• Recommendations
• The investment policy (IP) should not be
  pre-formulated
• Choosing a scheme on an ad-hoc basis should not
  be completely in hands of the investor
• In line with international standards, the IP
  should be determined after thorough analysis of
  the investors attributes
• Level of risk aversion must be determined by
  asset manager before offering an allocation style
• An institutionalized criteria of assessing
  investors level of risk aversion, such as that
  in Canada, should be introduced
• PFMs should require investors to fill and sign
  risk assessment forms in order to determine the
  level of risk
• Specialized software may be used for this purpose
• PFM must clearly explain the risk/return
  characteristics of a plan to the investor

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VPS International Comparison

• The Prudent Person Rule
• Governs the actions of the asset managers in
  developed nations such as US, EU, Canada, Finland
  and Japan, along with many developing countries
• Charges fiduciaries with conducting themselves
  with the same degree of judgment, reasonableness
  and prudence in administering the affairs of
  their clients, as they would in their own
  personal affairs
• The New Prudent Investor Rule
• Replacing the old rule due to certain unnecessary
  limitations
• When dealing in their clients affairs, the new
  rule calls on asset managers to observe how men
  of prudence, discretion and intelligence manage
  their own affairs, not in regard to speculation,
  but in regard to the permanent disposition of
  their funds, considering the probable income, as
  well as the probable safety of the capital to be
  invested"
• Calls for diversification, capital growth and
  safety, and implementation of investment
  decisions in the context of the whole portfolio
• Such rules should also govern the actions of
  investment managers in Pakistan in order to gear
  the investment process to the benefit of the
  participants

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VPS International Comparison

• Two investment regulation approaches
• Qualitative
• Quantitative
• Qualitative
• A prudent approach urging diversification
• No defined investment limits
• Followed in US, UK, Netherlands and Australia
• Quantitative
• Another prudent approach geared toward
  diversification
• Provides clear cut limits on asset allocation and
  investment avenues
• Followed in EU, Canada, India, Philippines and
  now in Pakistan

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VPS Qualitative Approach

• Features
• Diversification requirement is stated as general
  principle
• UK explicitly requires fiduciaries to develop a
  statement of investment policy to guide decisions
• US requires no explicit point in this rule
• Perspective in Pakistan
• Market too regulated to have qualitative approach
• Qualitative approach suits free markets
• Too many groups in small market constraints the
  ideal free market
• In essence, Qualitative approach is not
  appropriate for Pakistan

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VPS Quantitative Approach

• Main Feature
• Imposes quantitative limits related to
  diversification
• Examples
• Canada 5 in Real Estate Investment of funds
  portfolio 30 in foreign investment of funds
  portfolio
• Italy 15 in single investment of funds portfolio
• EU 30 cap on investments in unregulated
  markets 5 cap on investment in a particular
  scrip 10 cap on investment in scrips issued by
  a particular group
• Philippines 25 cap on investments in
  equities 25 cap on investments in real
  estate 10 of maximum allowable investment in a
  single asset

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VPS Investment Limits

• Equity Sub-Fund
• 5 cap on investment in shares of a company, 20
  in a sector
• 1 cap on investment in any one green field
  company
• Total investment in green fields not more than 5
  of NAV
• Investment in shares of only those listed
  companies that have an operational history of 5
  years
• Proposed amendments
• Green field projects must be clearly defined. Is
  a green field
• An IPO, or
• A newly established venture?
• Restriction of investment in issues of companies
  with less than 5 years of operational history
  hampers prospects to reap gains from certain
  excellent growth opportunities
• Some restrictions should be imposed to ensure
  liquidity of funds e.g. Indias proposal of PFs
  only investing in index shares

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VPS Investment Limits

• Debt Sub Fund
• Debt sub fund consist of tradable securities with
  weighted average duration of less than 10 years
• At least 50 of the assets will be invested in
  federal government securities
• Proposed amendments to overly restrictive
  regulations
• Duration term should not be restricted as
  investors with long term investment horizon
  (purpose of pension investment) will not be able
  to gain from high yield long term investments
• Minimum 50 investment in government securities
  would mean high credit quality but low returns
• Such restrictions carry no international
  significance especially in Pakistans emerging
  corporate bond market

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VPS Investment Limits

• Money Market Sub Fund
• Weighted average duration of the fund should not
  exceed one year
• No restriction on investment in government
  securities
• All other securities capped at 20
• Close to retirement a participant would be most
  heavily invested in the money market considering
  its safe and short term nature

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VPS A long way to go

• The VPS is yet in its infancy. Nevertheless, it
  is a much needed product and is the call of the
  time
• As individuals become more and more independent
  and living standards increase, saving up for
  retired life is the rational way to go
• The success of the system will be dependent on
  its adaptability to the joint-family system and
  demographics of the Pakistani society
• Awareness and education about the benefits of
  pension plans will be necessary for the VPS to
  gain widespread acceptance
• Following the examples of developed and other
  developing nations the VPS can be implemented in
  Pakistan. The product will be a success as long
  as it offers flexibility and ease to the
  investors to save up for their retired life

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• Thank You!