The recent past has taught us that placing all your eggs in one basket can create one huge omelette.  In the years preceding the bail-in of deposits of the island’s main banks, depositors relished in an abnormally high interest-rate environment. With deposits yielding rates up to 7% and the capital perceived as guaranteed, most provident funds placed their assets solely in a single asset class (cash) and in many cases only with a single financial institution.  With the ensuing haircut provident fund assets vanished overnight and the sanctity of bank deposits became a thing of the past.  It can be very rightly argued that what took place on March 2013 was unprecedented and nearly impossible to predict. The unthinkable became a reality.  While this may be the case, the fact of the matter remains that some very elementary principles of investing were ignored.  The purpose of this article is not to discuss the past and point fingers but rather to touch upon some basic principles of investing that Provident Funds may wish to consider going forward taking into account some of the main challenges they nowadays face.

What are the biggest challenges that Provident Funds face today?

Arguably one of the most important principles of investing is diversification, whether that is in geographical areas or asset classes.  The Cyprus economy, in GDP terms, accounts for around 0.02% of the world economy and although it may be normal for any investment portfolio to have some kind of local bias it is extremely risky to have a 100% exposure to a single country risk (not mentioning a 100% exposure to a single asset class in that country) as currently is the case with many provident fund assets. 

In the past few years the Euro is going through a zero/negative interest rate era (although Cyprus banks still offer some small interest on deposits) and this is not expected to change soon. With low returns and low expectations for a better yield soon, Provident Funds not only are having a hard time covering the cost of inflation for their members but for even covering the running expenses of the fund. In order to mitigate this effect, Provident Fund Committees need to examine placing assets in other asset classes such as fixed income and equities so that they attempt to increase their funds performance for the benefit of their members.

 

Provident Fund Committee members carry the burden of making investment decisions without having, in many cases, the investment knowledge or expertise. This may lead Provident Funds either taking investment decisions that may not compatible with the risk tolerance of their members or simply taking no action (i.e leaving all assets in cash) in the fear of taking a wrong decision. Taking into account that the management of a Provident Fund is a long term exercise that influences the retirement benefits of its members it is vital that the basic acceptable investment principles and methodologies are adopted throughout. 

The set up and maintenance of a Provident Fund entails significant fixed costs and the smaller the Provident Fund is, the higher the cost attributed to each member. Of course, additional to the fixed costs is the responsibility of Provident Fund Committees which at times may be too distracting and time consuming. In the next few months Provident Funds are expected to face increased regulatory requirements which will further increase costs (hence negatively impact the performance of the fund), responsibilities and administration.

In order to address many of the challenges mentioned above, a number of Provident Funds have already chosen to either outsource the administration of their fund or the investment management of the fund or both to professionals, by enrolling to turn-key occupational pension solutions such as the ones offered by the Insurance industry under Class VII of the insurance law (Management of Group Pension Funds).  These solutions undertake the entire administration of the Provident Fund and offer various investment options so that each individual member can select his own strategy according to their individual investment profile.  It is probably time for the Provident Fund community to rethink its operational model.

Christis Michaelides, BA, MSBA, MCIM

Ancoria Insurance Public Ltd