Pensions, liquidity and the right funds at the right time

DAVID LINDSAY speaks to Valletta Fund Management’s Kenneth Farrugia about VFM’s ongoing internationalisation process, Malta’s liquidity levels, the country’s equity and fixed income markets and VFM’s new products in this wide-ranging interview.

Valletta Fund Management has consistently been, without a doubt, Malta’s pioneer in fund management. Formerly jointly owned by Bank of Valletta and Rothschild, VFM recently saw Rothschild’s shareholding being absorbed by Insight Investments, which forms part of HBOS – the UK’s fourth largest financial services group.
The change in strategic partner, VFM’s Kenneth Farrugia explains, has brought added value to VFM’s operations – particularly in light of its internationalisation process and the pensions market, which VFM is actively eyeing.
He explains, "The pensions problem is an issue that has been placed high on Malta’s national agenda and having such an experienced player with established IT systems and products for the field will be extremely useful.
"Insight also shares VFM’s internationalisation vision and as such they will be channelling regional internationalisation business through VFM, very much in line with the philosophy we had shared with Rothschild.
"In this respect we’re on the same track as we were before. We’re still exploring the Maghreb region and after 12 months we’ve established good contacts. We now have a presence in Tunisia, we’ve gone into Egypt and we’re looking closely at Algeria, Morocco and Turkey."
VFM is actively looking at the entire spectrum these emerging markets have to offer and has appointed a large Egyptian brokerage firm with very good contacts in the Gulf region, which VFM is also looking to break into.
Of primary focus to VFM is selling its own funds across the region and, quite literally, structuring new funds for the region, such as the Mediterranean Rim Fund, which, Farrugia explains, has been an outstanding success in terms of performance. In fact, the fund has gained 25 per cent since October 2001.
But despite VFM’s enthusiasm for the emerging markets offered by the Mediterranean region, Malta’s fund management pioneers are still moving along with, and working in parallel to, the domestic market, which, Farrugia explains, offers significant potential.
He explains, "There is the pensions issue at hand and the fact that Malta is now joining the EU is also very positive. Malta as a base for fund administration is an excellent proposition for third party promoters and fits into our business model.
"On the one hand we provide fund administration for third parties and on the other we provide retail funds for the market. We’ve built our retail arm very strongly and today VFM’s assets under management are in the region of USD465 million. More than that, if you look at our fund range today, nearly half are third party funds. So we’re carrying administration for our funds and at the same time we’re providing fund administration for a growing number of third parties.
"The Maltese market still holds a great deal of potential and we will keep rolling out funds that we believe offer opportunities for the market.
"But for the time being we are building our core competence in the bond market and this has been done extremely well. “Despite the obvious difficulties of the equity market last year, our suite of products are relatively stable for two reasons: in the bond market we have gone predominantly for investment grade bonds and, secondly, they provide a reasonable rate of return."
But there and bonds and then there are bonds. Farrugia recalls the Argentine bonds fiasco, when so many Maltese had purchased Argentine bonds because they were sovereign, but, he reminds, Argentina is an emerging market and there are always risks associated with the high 10 and 11 per cent yields that were offered.
As far as the funds VFM launched last year go – the Sterling and Euro Income Bond Funds – VFM had predominantly invested in investment grade bonds, and with great success.
Farrugia comments on the bonds’ success, "Basically I think we played upon what investors were looking for – stability and competitive return. The issues were popular, having attracted Lm80 million from Malta, which is quite impressive even by international standards."
Does this, I ask, suggests that there really is a great deal of money in Malta looking for an investment channel?
Farrugia elaborates, "If you look at the Central Bank’s quarterly reports, you would see there is a significant amount of liquidity in Malta. I think this is, in part is due to the fact that people are not investing in the equity market in the same flows as they had in 1999 and 2000.
"Secondly, I believe we had a fair amount of repatriation of funds with the Investment Registration Scheme, which also boosted the liquidity of the Maltese.
"Thirdly, if you look at the fixed income market in Malta, the government, which is obviously looking to cap public debt, is steering away from issuing new bonds. We have had some new issues from government this year, but not as many as in past years.
"The corporate sector obviously played its timing right and issued a number of bonds on the market, which were taken up in, in some cases within a matter of hours. However, the new bonds on the market are still not matching the liquidity at hand."
VFM recently exceeded the 33,000 shareholder mark across its range of funds, which represents an impressive market penetration and continued growth is expected, particularly in terms of pension products.
Farrugia explains, "Now that there is a special funds act for pensions in place, which has paved the way for occupational private pensions schemes, this area of the market is expected to begin growing. However, there are no tax benefits attached to the act as yet and, as such, these products are not as attractive as they could be. However, if conditions such as those that exist in the UK were implemented here, such as being able to offset contributions against personal taxation, it would be a great benefit. But I do think we’re heading in that direction.
"Everyone acknowledges the problem we have in dealing with the welfare gap and the minister recently, quite adamantly, echoed this, so I think we’ll see a concrete roadmap for this problem drawn up in the near future.
"However, at the same time we need to develop the local stock exchange as well. Of course it’s good to develop a pensions programme but then one must also ensure that the local stock exchange offers sufficient instruments for pension products to diversify in, otherwise money will begin flow out of the country. The market needs to be deepened, we need more issues on the market so products can be diversified properly and for more liquidity to be injected into the market.
"Developing the Exchange further is of paramount importance. We need to create a market for these products through introducing a wider array of instruments both on the fixed income side and on the equity side, in tandem with developing the pensions legislation. In that way we will be hitting two birds with one stone: developing pension products for the Maltese while at the same time developing the local market so these pension products can invest in the local market."
The local markets, particularly the equity market, have been hard hit of late but Farrugia remains confident they will pick up again.
He explains, "It has been a challenging time for many fund managers, but I have seen market conditions easing, even on the local side. If you look at the Exchange’s quarterly statistics, you will notice that the last quarter of 2002 was the first quarter, after a multitude of quarters, in which we had positive results in the index, the same goes for the first quarter of 2003 and even now we will most likely have a positive return for this quarter as well. This augurs well and we are seeing a certain level of support of prices on the Exchange.
"However, I always say that when investing in a fund, especially in Malta, it’s useless to just look at the face value of the prices of the components of the fund - you have to look at the fund’s portfolio and the companies it is investing in."
There has been virtually endless talk of developing Malta as a regional financial services centre, I ask Farrugia how he sees Malta filling this role and how EU membership could facilitate the vision becoming a reality.
"From the fund management point of view," Farrugia explains, "EU membership is a very positive step because we will gain direct access to the European market. For example, on the fund administration side we often receive enquiries from people interested in setting up fund administration activities in Malta and licensing their funds in Malta. However, the problem invariably arises that if they want to market their products in Europe, with Malta’s status as a non-EU member they would have to seek approvals from each jurisdiction in which they wanted to market their products.
"What happens now with the ‘single passport’ Malta’s financial services practitioners will enjoy with membership, is that they will be able to license their funds in Malta, have them administered in Malta and market them freely across the EU.
"The MFSA has been quite proactive in this respect and they’ve aligned our legislation with that existing in the EU, so there will be no significant changes to implement. The transition, from our point of view, will be a seamless integration.
"Secondly, the perception of Malta will also change. EU membership automatically implies that there are good standards in Malta and I think market makers will look more favourably at the local market once Malta is an EU member."
In the short term, VFM expects to continue looking closely at the pensions issue, while also continuing to launch new, innovative products still lacking from VFM’s portfolio such as funds dealing with European equities, European bonds, and the Far East.
But any new fund launched by VFM will follow on the heels of the recently launched Monthly Income Fund, the first fund of its kind denominated in Maltese liri.
Farrugia explains the concept behind the fund, "On one hand we looked at what’s happening in Malta, where there is a lot of liquidity and on the other we looked at the bond market in Malta, which is small and is already well-serviced the by our other products.
"So the alternative would be to invest in the foreign bond market, which of course creates currency risks. What we did was to look at the perspective of the investor, who would, from a currency standpoint, want to mirror the Maltese lira’s currency basket, which is comprised of 70 per cent euro, 20 per cent sterling and 10 per cent dollar. We looked at the bond market in Europe, which we know is growing from our experience with our euro and sterling bond funds, and came to the decision to launch a bond denominated in Maltese liri that would invest in investment grade bonds in the same proportions as the lira currency basket.
"We then looked at the distribution options and, given our experience in distributions and our fully fledged distribution systems, we decided to go for the monthly distribution.
"I think this product filled a market void, by being the first of its kind denominated in Maltese liri. It’s a one stop shop for investors. Firstly, its suitable for investors seeking regular income flows since it pays out on a monthly basis. But secondly, investors who traditionally invest in the local market can now diversify in the foreign market with a single product, whereas if you wanted to diversify overseas before, you would have to buy a variety of bonds to link to the Maltese currency basket and there are costs associated with this. And if the basket changes, as it did last year, you would have to adjust your exposures accordingly. So we created this single product to meet these needs and the response to the product has been very good.
"Obviously, we’re launching our products where there is a demand for them and demand for equity products has been very weak over the last few years. However, a recent report said that for nine consecutive weeks the inflows of US equity mutual funds have exceeded the outflows. That’s a good sign. I don’t think we’re out of the woods yet and perhaps we’ll have to wait till the end of the year to ascertain what level of growth we will see in the States, which is a good gauge being the strongest economy, and in Europe as well.
"But I think that of all the uncertainties we’ve been faced with – economic, political and accounting - the accounting scandals were the final blow to investor confidence. It’s a major problem when you cannot rely on the accounts to ascertain whether share prices are overvalued or undervalued. What happens is that it spirals itself to other companies irrespective of whether they have good corporate governance themselves and the sentiment spreads across the whole market. These accounting uncertainties were a real worry and there was a fear of contagion in Europe. So companies are now making sure their accounting is transparent, fair and reflects what everyone expects from them."
But is there a real correlation between what happens on the international markets and the Maltese market, I ask?
"Let’s put it this way, on the fixed income side, I think we are converging with what’s happening abroad, particularly in Europe. Considering that our basket is comprised 70 per cent of euro, we see a convergence of what’s happening in the euro currency and what’s happening in Malta. The Central Bank seems to be aligning itself and cutting interest rates in line with the Eurozone."
But whatever the future holds, VFM, with its thumb firmly placed on the pulse of the industry, is without a doubt well placed to meet investors’ evolving needs.