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Voluntary Pension System VPS

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The Voluntary Pension System a self-contributory pensions savings scheme ... Relaxation for participants joining the pension plan after the age of 41 ... – PowerPoint PPT presentation

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Title: 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

4
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

5
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

6
VPS Investment Process of an IPA
Part 1 Formation of an Investment Policy
7
VPS Investment Process of an IPA
Part 2 Monthly Fund Flow
8
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

9
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

10
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

11
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

12
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

13
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

14
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

15
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

16
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

17
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

18
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

19
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

20
  • Thank You!
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