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Savers chase yield

Central Europeans’ appetite for more sophisticated and varied products is growing, providing the region’s big retail banks with an opportunity to cash in. The mutual fund business, in particular, could benefit, reports Nicholas Spiro.
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It is only six months since the EU added eight central and eastern European members to its ranks, yet the region’s investment funds market is in full swing. In the past couple of years, a growing number of central Europeans have been turning to mutual funds as a depository for their savings.

Privately-managed pension funds were launched successfully in Poland in the late 1990s. Assets under management reached 53bn zlotys (E12.3bn) at the end of August and account for nearly 30% of the Warsaw bourse’s free float. Now mutual funds are catching on, as lower interest rates cool the demand for traditional savings accounts and the region’s stock exchanges reach dizzying heights.

“There is a clear and, in my view, irreversible trend toward higher-yield investment products. The process may pause during periods of rising interest rates but the trend will continue,” says Roy Hutchinson, vice-president of marketing for central Europe at Citibank Handlowy in Warsaw.

While the Czech Republic has experienced the biggest shift in savings from bank deposits into investment funds due to rock-bottom lending rates and favourable tax regulations, Poland has the most vibrant mutual fund industry. Following the introduction of a 20% tax on savings account interest in December 2001, scores of Poles moved part of their savings into bond and money market funds. Polish mutual funds’ assets under management have tripled since January 2002 to 35bn zlotys (E8.1bn).

“The tax was the catalyst. Although pension funds benefit enormously from having [Poland’s social insurance office] as their distributor, they now look at us as competitors,” says Miroslaw Panek, head of ING Investment Funds in Warsaw.

Dan Kingsbury, head of UniCredito-owned Pioneer Investments New Europe in Warsaw, says: “I thought there would be just one big punch after the tax and that’s it. I was wrong. This woke the public up to the idea that they can buy mutual funds from banks.” According to a recent report by Pioneer on household wealth in central Europe: “Financial convergence will favour portfolio diversification, with a reduction in [bank] deposits and an increase in other [products], including mutual funds.”

Dariusz Gorski, head of central European research at Deutsche Bank in Warsaw, agrees: “Over time, the structure of savings will converge.”

Markets develop

The Czech Republic boasts the region’s most developed mutual fund market. According to data from Pioneer, 8.4% of Czechs’ savings were in mutual funds at the end of last year, compared with 6.9% in Hungary (down from 8.6% in 2002 due to an unexpectedly sharp rise in interest rates) and 7.3% in Poland. With lending rates as low as 2.5% in 2002, compared with 6.75% in Poland and 8.5% in Hungary, many Czechs were lured to higher-yielding mutual funds, including equity-linked foreign funds which enjoy favourable tax treatment.

Fund managers had to work hard to build trust in their products. “Our investment fund industry was tarnished by the ‘voucher’ privatisation scandals of the early 1990s. We had to inject credibility into the industry. The good standing of the market was established on the fixed-income side, as Czechs are very conservative,” says Petr Zapletal, head of Erste-owned Ceska Sporitelna’s asset management subsidiary in Prague.

Mr Kingsbury says: “The [Czech] investment industry did itself no favours by failing to distinguish between investment funds and fraudulent companies.”

In neighbouring Slovakia, mutual funds are at an earlier stage of development but are growing rapidly. “We’re probably two to three years behind because of higher rates but bond and money market funds are taking off. We don’t really have an equity market but in a couple of years’ time, we hope to sell equity-linked third-party funds,” says Roman Vlcek, the head of Erste-owned Slovenska Sporitelna’s asset management unit in Bratislava.

The region’s large retail banks are best placed to market both white-label and branded products. “Banks are at the heart of people’s financial affairs and are also performing an educational role. When they realise their full potential [in terms of cross-selling], they can be a ferocious force,” says Mr Kingsbury, whose company uses its parent firm’s Polish subsidiary, the mammoth Bank Pekao, to distribute its funds.

According to Mr Gorski: “Pekao is earning nice fees from mutual funds – especially mixed funds. They helped start the rally.”

Retail competition

Yet industry experts say that competition is intensifying. “I would not over-emphasise the importance of retail banks. The notion of a [captive] customer base is unconvincing. There are no long-term relationships in this part of the world. Customers aren’t loyal. Clients know they have many options,” notes Piotr Czarnecki, the head of Raiffeisen bank in Warsaw.

Mr Panek says: “Having a major retail bank at your disposal is crucial but, if you look carefully, a high percentage of the distribution [in Poland], particularly for third-party products, is through brokers.”

A sign of the increasing appetite among central Europeans for more sophisticated and varied products is the shift from popular fixed-income funds to balanced, equity and foreign strategy funds. With GDP growth in Poland at just over 6% in the second quarter of this year and the Warsaw bourse at a record-high, consumers are piling into balanced and equity funds. According to data from Deutsche Bank, these products accounted for half of Poles’ mutual fund holdings at the end of August, compared with only 11% in January 2003. “The fixed-income segment has shrunk. In the space of just one year, we have seen a doubling in the balanced/equity portion of the market. That’s quite something,” says Mr Kingsbury.

Yet rising interest rates in Poland – they now stand at 6.5% and are expected to rise further because of inflationary pressures – are increasing the appeal of bank deposits. “We have witnessed a slowdown in the market because popular fixed-income funds lost their allure. Bank deposits offer better returns right now because funds only show historical returns. If rates are rising, the historical performance of funds does not look good. But this is just a temporary lull. The outlook for mutual funds [in Poland] is rosy,” insists Mr Panek.

Global players

Although very few central Europeans are investing directly in mutual funds (rather than buying them from banks), specialist providers are eyeing up the region. Citibank’s Mr Hutchinson says: “Affluent customers already tend to be visibly more demanding than they used to be, and in need of more sophisticated products with potential for higher yield.”

This presents opportunities for global investment groups, such as Fidelity and Franklin Templeton, to enter the market.

While unfavourable tax treatment in Poland – locally registered funds pay a 19% tax, while foreign funds pay 40% – has deterred international players from entering the market, Templeton is already present in the Czech Republic and the Baltic states. “We’re having a renewed look at a number of countries in the region, including Poland and Hungary. The tax issue is a concern but we hope this will change soon,” says Jed Plafker, managing director for northern Europe, Middle East and Africa at Templeton Investments in London.

He believes that as central European investors become more sophisticated, they will require specialist expertise. “The domestic players can’t do every asset class. For retail investors, the traditional mutual fund [provided by a non-bank] is the next logical step,” he says.

Mr Hutchinson believes that Poland, with the largest population and the highest stock market capitalisation in the region, has the biggest potential for mutual fund sales. He stresses, however, that “the investing pattern will depend on many factors, such as the dynamic of interest rate decreases and the general economic situation”.

The Czech Republic is making the most headway in setting up a proper regulatory framework for new products. New legislation allows investment in riskier assets, such as property and hedge funds. “This just shows that central Europe is leap-frogging many west European markets in certain areas,” says Mr Kingsbury.

As central European countries prepare to adopt the euro by the end of the decade, asset managers are already fretting about the future of the industry in the eurozone. “The big question for us is whether we will survive as a domestic segment once the currency barriers disappear,” says Mr Panek.

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Read more about:  Central & Eastern Europe