PUBLIC PENSION FUND MANAGEMENT IN MENA

1. PUBLIC PENSION FUND MANAGEMENT IN MENA Dimitri Vittas FSD, World Bank

2. INTRODUCTION • Difficult to undertake because of lack of detailed data, especially on performance. • Need to take regional and country context into account. • The structure and approach of the paper is to set out context, assess institutional record, highlight obstacles, and indicate prospects.

3. CONTEXT 1 • Focus of paper on Egypt, Jordan, Morocco, Tunisia and Saudi Arabia. • All countries effectively have mono-pillar systems. Non-state provision is limited and not well documented. • Basic reliance on funded “scaled premium” public pillars.

4. CONTEXT 2 • Most countries have young populations, young systems, weak capital markets. • Accumulation of large reserves in some countries because of high contribution rates. • Many arguments in favor of mixed multi-pillar systems. Strong emphasis on “empirical agnosia”.

5. “EMPIRICAL AGNOSIA” • Pension contracts span 60 years or more. Data covering as long as 200 years are needed for empirical verification of any system. Over such long periods, there are massive changes in production, information, financial and medical technology. Multi-pillar systems allow risk diversification in the face of uncertainty.

6. INSTITUTIONAL RECORD EGYPT 1 • Large social insurance system with extensive coverage and high contribution rate (26% for pensions). • Large SIS reserves correspond to 38% of GDP. • Total contractual savings amount to 45% of GDP. Mutual funds 2% and equity market capitalization 36% (1999).

7. INSTITUTIONAL RECORD EGYPT 2 • Poor investment performance. • In June 2000, 92% of assets placed with National Investment Bank (NIB), 1% in equities, 6% in bank deposits. • NIB is a unit of Ministry of Planning, supporting public utilities, public works, and social projects.

8. INSTITUTIONAL RECORDEGYPT 3 • Interest rate on reserves was fixed at 6% for the 1980s and early 1990s. With high inflation, that reached 25% at its peak, the average real rate of return was -11%. Treasury payments mitigated this effect. • Interest was raised to market levels on new funds and reinvested reserves. With declining inflation, real returns reached 7% in late 1990s.

9. INSTITUTIONAL RECORDEGYPT 4 • No impact on capital market development. Limited entry into equities. • NIB is suffering huge losses and a growing financial deficit. • Private pension funds are small, invest 60% in traded government bonds, and are actuarially weak. • Insurance companies also are small but invest 35% in equities.

10. INSTITUTIONAL RECORDJORDAN 1 • Social Security Corporation (CSC) assets amount to 25% of GDP. • Insurance company assets amount to 3.5% of GDP. No detailed data on provident funds but assets estimated at 2- 3% of GDP. • Total contractual savings: 30%. Equity market capitalization: 49%.

11. INSTITUTIONAL RECORDJORDAN 2 • SSC invests 19% in equities and 10% in bonds. Loans represent 11% and bank deposits 52%. Marketable securities rose from 19% in 1996 to 29% in 2000. • Significant and persistent reverse maturity transformation. • Positive annual cash flow and positive real returns. Modest contribution rate.

12. INSTITUTIONAL RECORDJORDAN 3 • SSC is largest institutional investor. It is constrained by absence of instruments and prohibition of overseas investments. • Strong support for the development of mortgage refinancing and securitization. • Limited impact on capital market development.

13. INSTITUTIONAL RECORDJORDAN 4 • Efforts to modernize investment approach have yet to bear fruit. • Insurance companies invests 50% in securities, 30% in bank deposits and 20% in accounts receivable. • Insurance industry is highly fragmented despite creation of modern regulatory agency.

14. INSTITUTIONAL RECORDMOROCCO 1 • There are several pension funds. 6 cover employees of public corporations, 2 are for civil servants, and 3 for private sector employees. • The total assets of these institutions amount to 12% of GDP (1999). Insurance company assets add another 12% of GDP, mutual funds 7% and postal savings 2%, totaling 33%. Equity market capitalization: 40%.

15. INSTITUTIONAL RECORDMOROCCO 2 • Caisse de Dépôt et de Gestion (CDG), public sector agency, is responsible for managing the assets of several of the pension funds. Its assets represent 7% of GDP. • CDG has traditionally invested in government bonds (over 50% and tourism) but has recently started to diversify into equities.

16. INSTITUTIONAL RECORDMOROCCO 3 • CDG deducts a significant spread and pays a lower return to its captive clientele of pension funds. • It is currently improving its asset management capabilities and is likely to adopt a more modern approach in the future, while its client funds may be allowed to hire other asset managers. • The real returns of one of the funds (RCAR) have been high.

17. INSTITUTIONAL RECORDMOROCCO 4 • The complementary fund for private sector employees, known as CIMR, uses guaranteed investment contracts from local insurance companies and also invests in equities, including some foreign ones. • Its returns have been relatively high but it faces serious actuarial problems because it is not fully funded and company participation is voluntary.

18. INSTITUTIONAL RECORDTUNISIA 1 • 2 main pension funds for public and private sector employees. Supplementary company schemes undocumented. Total assets equivalent to 9% of GDP. Insurance companies add another 5% and mutual funds 5%. Total institutional savings: 19% of GDP. • Equity market capitalization: 14% of GDP.

19. INSTITUTIONAL RECORDTUNISIA 2 • Assets of pension funds mostly in money market instruments (57%). Bonds (19%) and loans (12%). Equities represent only 4%. • Reverse maturity transformation. • Improvement in recent years, move away from subsidized rental housing and low interest housing loans.

20. INSTITUTIONAL RECORDTUNISIA 3 • Insurance companies invest mostly in bonds 32% and equities 17%. Claims account for 33%. • Mutual funds are basically bond funds. Only 6% in equities, rest in money market instruments and government or corporate bonds.

21. INSTITUTIONAL RECORDTUNISIA 1 • Shortage of instruments. • Policies to encourage recourse to market finance. • Prohibition on investment overseas. • Ambitious reform program in regulation, supervision, accounting, and governance, but impact is still small.

22. INSTITUTIONAL RECORDSAUDI ARABIA 1 • Saudi Arabia has 2 very large pension funds with assets reaching 165% of GDP (based on estimate of WB study). Mutual funds add another 7% of GDP. Equity market capitalization is 45% of GDP. • Large size of pension funds is explained by young age and structure, high contribution rates, and high returns.

23. INSTITUTIONAL RECORDSAUDI ARABIA 2 • Asset allocation of the two funds combined is 48% government bonds and loans, 18% bank deposits, 4% local equity 4% real estate, and 26% foreign bonds and equities. • Overseas assets correspond to 43% of GDP. Local financial markets are too small for the size of the pension funds.

24. INSTITUTIONAL RECORDSAUDI ARABIA 3 • Management of foreign portfolio is supported by reputable international advisors. • They help in setting long-term investment strategies, selecting experienced asset managers, drafting investment guidelines, and monitoring performance. • Objective is to earn modest excess returns over the World Index.

25. INSTITUTIONAL RECORDSAUDI ARABIA 4 • Saudi Arabia shows benefits of international diversification. • Shortcomings are lack of transparency and high concentration of financial power. • Limited impact on developing local markets because of holding nontraded government bonds and absence of pluralistic structure.

26. OBSTACLES AND CONSTRAINTS 1 • Most, if not all, MENA countries suffer from: • Weak financial markets and shortage of financial instruments. • Weak fund and corporate governance. • Widespread public mistrust of financial institutions and markets.

27. OBSTACLES AND CONSTRAINTS 2 • Prohibition of overseas investment complicates fund management but there is very weak political support for international diversification. • Shortage of skilled professionals and experienced regulators. • Weak custodial services. • Lack of transparency and external scrutiny.

28. OBSTACLES AND CONSTRAINTS 3 • Extensive second-guessing of public sector agencies. • Difficulty of ensuring insulation from political interference. • No historical precedent of positive impact on capital market development by dominant public sector agency.

29. “IMPACT” PRECONDTIONS • Critical Mass • Conducive Regulations • Optimizing Behavior • Pluralistic Structure

30. PROSPECTS 1 • Need to emphasize primary objective of pension systems: payment of secure, affordable and adequate pensions. • Underscore advantages of mixed multi-pillar systems. • Financial markets exhibit persistent deviations from trend over prolonged periods.

31. PROSPECTS 2 • Develop depth and efficiency of financial markets to instill confidence and trust. • Strengthen regulation and supervision. • Enhance transparency and external scrutiny.

32. PROSPECTS 3 • Establish independent investment committees. • Set objective criteria for selection of asset managers, including foreign experts. • Hire efficient custodial services for safekeeping of assets and monitoring of performance. • Set guidelines for asset allocation. • Emphasize diversification and market returns. • Use asset swaps for international diversification.

33. PROSPECTS 4 • Encourage pluralistic structure, competition, innovation and efficiency. • Decentralize asset management. • Authorize contracting out of employers and/or employees, for part of benefits. • Create robust regulation and proactive supervision.