Past

Performance and Costs of Bulgarian Pension Funds or

How two pensions are less than one in Bulgaria

Lubomir Christoff, PhD, ChFC
5 July 2018
lchristoff@gmail.com
+ 359 89 789 9152

TAKEAWAYS

• Returns are period-dependent and highly sensitive to the market cycle phase;
• Pension funds in Bulgaria have produced below market returns on a risk adjusted
basis over the 10-year period, ending in 2017. In the more recent 3-year period as
well as in 2017, pension funds’ returns have beaten the benchmark;
• Investors have obtained less than 30% of the pension fund returns in real terms in
the past 10 years with the remaining over two thirds of the returns paid in fees and
offsetting inflation. This result has improved markedly in more recent shorter
periods with real returns accruing to investors accounting to between 42% and 69 %
of pension funds’ returns with the remaining 31% to 58 % being paid in fees and
offsetting inflation;
• Two pensions are less than one. Under the current Bulgarian legislation participating
in the mass Universal Pension Funds is detrimental to investors as the
“supplemental” UPF pension cannot offset the reduction of the state pension, which
investors would have been entitled to had they avoided contributions to UPFs
altogether. This is due to the fact that past as well as future expected real returns of
pension funds’ portfolios cannot yield high enough return in order for the UPF
pension to fully replace the reduction in the state pension entitlement.

* * *

CONTENTS
ABSTRACT 2
INVESTOR VS. TOTAL RETURNS 3
PENSION FUNDS’ PERFORMANCE AGAINST A BENCHMARK 5
DECOMPOSITION OF PENSION FUNDS’ RETURNS INTO FEES, INFLATION AND REAL INVESTOR RETURN 6
UNIVERSAL PENSIONS FUNDS: THE REQUIRED RETURN OR HOW TWO PENSIONS IN BULGARIA ARE LESS THAN ONE 8
APPENDIX I - BENCHMARK 11
APPENDIX II - METHODOLOGY AND DATA 13
BIBLIOGRAPHY 15

1

Abstract

The European Commission has requested that European Supervisory Authorities report on
the costs and past performance of main categories of retail financial products, including
pension products1.

I report costs and past performance of the three main categories of pension funds available
in Bulgaria in the trailing 1-, 3-, 7 and 10 years ending in 2017.

Member State: BULGARIA
Product Category: Pension funds
Level of Aggregation: By pension funds category:
- Universal Pension Funds (UPF)
- Voluntary Pension Funds (VPF)
- Professional Pension Funds (PPF).
Returns: Nominal Returns:
- Total Return (net of fees)
- Gross Investor Return (net of fees)
- Net Investor Return (gross of fees)
Real Returns:
- Net Investor return (adjusted for inflation, gross of fees).
Time Horizon: Trailing 1-, 3-, 7 and 10 years, ending in 2017.
Inflation: Bulgarian Consumer Price Index

Data and Calculations: “BG-PFC&PP-EN.xlsx” - https://bit.ly/2NBIpfH




The paper is organized as follows: In the first section I compare gross investor to total
returns, following the Morningstar approach2. Total returns refer to returns due to both,
capital appreciation and re-invested dividends and are calculated as time-weighted returns.
Gross investor returns are calculated as asset-weighted (money-weighted) returns and
represent the annual average return, which makes the capital, accumulated at the end of
the period equal to the initial capital, while taking into account the size and the timing of all
cash inflows and outflows.

1
European Commission. (2017). “REQUEST TO THE EUROPEAN SUPERVISORY AUTHORITIES TO REPORT ON THE COST
AND PAST PERFORMANCE OF THE MAIN CATEGORIES OF RETAIL INVESTMENT, INSURANCE AND PENSION PRODUCTS”
Ref. Ares(2017)5008790 - 13/10/2017) https://ec.europa.eu/info/sites/info/files/171013-request-to-esas-to-
report_en.pdf
2
Morningstar®. (2010). “Morningstar® Investor Return ™”. Morningstar methodology paper.
https://corporate.morningstar.com/us/documents/MethodologyDocuments/MethodologyPapers/InvestorReturnMeth
odology.pdf

2
In the second section I construct a benchmark, consistent with the legal investment policy
constraints on pension funds’ asset management and compare the funds’ performance
against this benchmark.
In the third section I break the Gross Investor returns down into three components: net
investor real return, inflation and fees and charges as requested by the European
Commission, following the ESMA3 approach.
In the last section I address the issue of whether or not universal pension funds(UPF) – the
largest pension vehicle in Bulgaria, have the capacity to ensure “supplemental” pensions.
The conclusion is that under the current legislation, a UPF pension will be insufficient to
compensate for the reduction of the state pension of those, who have contributed to a UPF.
This outcome is ensured by the fact that neither during the past 16 years, nor in the next 20
years or so under reasonable capital markets assumptions, can an investor in UPF expect
the real return, necessary for the UPFs to disburse a truly supplemental pension, one that
fully offsets the reduction of the state pension. On the contrary, UPF pensions will reduce
pension income, compared to the state pension, contributors would have been entitled to if
they had avoided the UPFs altogether. This is due to the fact that a UPF pension will be
smaller than the reduction in the state pension for those, who have contributed to UPFs.
Thus two pensions in Bulgaria are less than one.
I describe the construction of the benchmark, the methodology and data sources in two
appendices. The full data and calculations are available in “BG-PFC&PP-EN.xlsx” -
https://bit.ly/2NBIpfH

Investor vs. Total Returns

I start by calculating the “gap” between pension funds’ nominal returns (total returns) and
gross investor returns, following the Morningstar approach.

3
ESMA. (2017). “ESMA Report on Trends, Risks and Vulnerabilities”, No. 2, p. 39.

See Appendix II for the Methodology and Data Sources.

The “gap” is predominantly positive across pension vehicles for all periods, except for
investors in voluntary pension funds in 2017 and the three-year period, ending in 2017. This
means that, generally speaking, investors have fully captured and even exceeded the
returns, produced by pension funds they have invested in. This result is due to the bull
market conditions of the past 7-8 years and can be explained by the fact that investor
returns are assets-weighted and, therefore, returns in the most recent years dominate the
outcome for the whole period, while Total returns are time-weighted and annual returns
carry equal weights4.

4
Sit, Harry. (2012). Does The DALBAR Study Grossly Overstate The Behavior Gap? https://www.kitces.com/blog/does-
the-dalbar-study-grossly-overstate-the-behavior-gap-guest-post/

4

Pension funds’ performance against a benchmark

Evaluating pension funds’ performance requires comparison with a benchmark. Since
pension companies in Bulgaria do not report their results against benchmarks, I’ve
constructed a crude and simple one, blending European equity (35 %) and Euro government
bond (65 %) indexes. This allocation is consistent with the investment constraints imposed
on pension funds by law5 (see the Appendix I for details). It is to be expected that actual
pension funds’ performance will deviate from the benchmark, since, as opposed to the
benchmark, pension funds invest in:
- More asset classes such as corporate and municipal bonds and real estate and
- Invest in securities of Bulgarian issuers, which are not reflected in the benchmark.
Thus, the benchmark is less risky than Bulgarian pension funds’ portfolios as it avoids the
credit risk, inherent in corporate and municipal fixed income securities as well as the
idiosyncratic Bulgarian country risk. Nevertheless, the comparison is illuminating as the
benchmark is investable and its performance could have been obtained by investing in just
two ETFs6.

FIG 1.



5
Social Security Code, art. 176 -178. In Bulgarian. http://noi.bg/images/bg/legislation/Codes/KCO.pdf
6
For example Source STOXX Europe 600 UCITS ETF
https://www.powersharesetf.com/gb/institutional/en/product/source-stoxx-europe-600-ucits-etf/index-components

and iShares € Govt Bond 7-10yr UCITS ETF https://www.ishares.com/uk/individual/en/products/251738/ishares-
euro-government-bond-710yr-ucits-etf?siteEntryPassthrough=true&locale=en_GB&userType=individual

5

While more recently pension funds exhibit higher nominal returns compared to the
benchmark, they are trailing it in the last 10 and 12 and a half years since 1 July 2004. Thus,
over the longer term, pension savers in Bulgaria have received below market risk-adjusted
returns in all three main categories of pension funds – universal, voluntary and professional.
It has to be noted that the actively managed pension funds did not protect pension savers
from the 2007-2009 market crash as the losses were commensurate with the dip in the
benchmark.

Decomposition of Pension Funds’ returns into fees, inflation and real Investor return

I have reported above nominal gross investor returns in pension funds net of fees and
charges. To estimate the extent to which fees and charges have reduced Investor returns, I
compare Investor returns, calculated on both, gross and net of fees basis. Further, I
calculate real investor returns (on a gross of fees basis) to estimate the impact of inflation
on the real purchasing power of pension savings. The results are reported in Tables 2UPF,
2VPF and 2PPF in the Excel file7 and illustrated on figures 2UPF, 2VPF and 2PPF below.

FIG 2 UPF

7
“BG-PFC&PP-EN.xlsx” - https://bit.ly/2NBIpfH

6


FIG 2 VPF

FIG 2 PPF

7
 In the recent 3 and 7 year periods pension savers across all pension vehicles have realized
positive real returns of between about 2 % and 3.6 % annually. This is due to a combination
of three factors:
- The general market upswing since 2010, which helped nominal returns,
- The sharp decline in the inflation rate and the outright deflation in 2014-16, which
boosted real returns and
- Slightly declining fees and charges as percentage of the gross return.

Investors get about a third of the pension funds return with the remaining two thirds
consumed by fees and inflation

Over the 10-year period ending in 2017, however,
- Real investor returns have been unimpressive at about 1 % annually with investors in
voluntary pension funds actually suffering a negative real return of minus 0.3 %;
- Fees and charges have “eaten” between 33 % and 42 % of the nominal annual returns
(voluntary and universal pension funds respectively). This compares unfavorably with
EU mutual fund industry on average, where fees and charges reduce the investor return
by a little less than 20 %.8;
- 30 to 40 % of the nominal annual returns of universal and professional pension funds
compensated for the inflation rate, while a whopping 80 % of the voluntary pension
funds was needed to just offset the inflation.
- With the inflation rate returning to a more normal level of 2.4 % in 2017, it “ate” about
a third of the nominal returns for that year.

Universal Pensions Funds: The Required Return or How Two Pensions in Bulgaria are
less than One

Investors in the universal pension funds are likely to see their pension income eroded as a
consequence of being “insured” in UPFs due to the lower than necessary net investor
return. Universal pension funds are supposed to pay out “supplemental” pensions to future
retirees. The contributions to UPFs, however, are funded at the expense of contributions to
the state social security. Therefore, those contributing to UPFs will see their state pension
reduced proportionally to their reduced contribution to the state social security insurance.
So, for a UPF to ensure a truly supplemental pension, it has to compensate for the reduction
of the state pension in the first place.
My research shows9 that in order for the UPF pension to just offset the reduction of the state
pension, it is necessary and sufficient that the pension savers’ real return exceeds the rate of
growth of the average insurable income for the country (AII) over the entire working carrier.
In the past 16 years (2001-2017) the picture was the complete opposite – the real rate of
growth of AII has exceeded the real pension return in UPF over the trailing 1-, 3-, 7-, 10
years and since April 2002.

8
Table V.3 Reduction in fund returns – TER and load charges, in: ESMA. (2017). ““The impact of charges on mutual
fund returns” in: ESMA Report on Trends, Risks and Vulnerabilities, No. 2., p. 39.

9
Christoff, Lubomir, (2018). “Pension (In)adequacy in Bulgaria (2018 Edition)” (In Bulgarian, March 27, 2018).
Available at SSRN: https://ssrn.com/abstract=3150489 or http://dx.doi.org/10.2139/ssrn.3150489

FIG.3

Going forward, the first cohorts which will retire in 2042 after having contributed to UPF
over their entire carrier, will need to realize on average a 4.5 % real return annually
between 2018 and 2042. This has not only not happened over any extended period in the
past but is highly unlikely to happen in the future, as capital market assumptions point to an
expected real return of a balanced portfolio of about 3 % over the next 20 years10
Thus, two pensions are less than one in Bulgaria, since a “supplemental” UPF pension
cannot fully offset the reduction of the state pension. Participation in universal pension
funds is detrimental to consumers as it reduces their pension income compared to the
pension they would have been entitled to had they not participated in UPF at all.

The effect of “two pensions are less than one” is due entirely to the legislation and is a side
effect of pension reforms, introduced in 2015, which boosted state social security
entitlements without affecting at all the potential of pension funds to achieve better returns
for investors. Therefore, no tweaking of investment policies or further compression of fees
and charges is likely to reverse the fact that UPF are detrimental to future retirees by
reducing their pension income.

10
Dobbs Richard, Tim Koller, Susan Lund, Sree Ramaswamy, Jon Harris, Mekala Krishnan and Duncan Kauffman.
(2016). “DIMINISHING RETURNS: WHY INVESTORS MAY NEED TO LOWER THEIR EXPECTATIONS”, McKinsey &
Company https://www.mckinsey.com/industries/private-equity-and-principal-investors/our-insights/why-investors-
may-need-to-lower-their-sights

9
To avoid this outcome, further changes in legislation could make contributions to UPF truly
additional, over and above the mandatory contribution to the state social security. This will
ensure that UPF will be able to ensure supplemental pensions, the size of which will depend
on the real return, actually obtained by pension savers.

10

Appendix I - Benchmark

I construct a blended benchmark to compare pension funds’ returns against. The benchmark
is a weighted average of European equity (35 %) and Euro government bonds (65 %). The
equity portion is represented by the STOXX Europe 600 index of large and medium sized
European companies and the fixed income portion is represented by the Euro Government
Bond 10Yr Term Index (BCEX4T)11 . The weights are consistent with the legal restrictions on
UPF investment policy12

Methodology: Author’s calculations, based on daily data, published by the Financial
Supervisory Commission.
Data and Sources:
UNIDEX – Universal funds unit price (daily data);
VOLIDEX – Voluntary funds unit price (daily data);
PROFIDEX – Professional funds unit price (daily data).

- UNIDEX, VOLIDEX and PROFIDEX unit prices are modified weighted averages of the unit
price of each of the nine pension funds. The indexes are asset-weighted per pension fund
(provider) with the weights for the two largest funds capped at 20 % and their excess weight
redistributed among the remaining seven funds of the respective category (universal,
voluntary, professional)13
Source: Financial Supervisory Commission, Unit values of pension funds
http://www4.fsc.bg/units.asp

- EuroSTOXX 600 index (EURSXX)
Source: STOXX Europe 600 Index EURSXXP, http://quotes.wsj.com/index/XX/SXXP/historical-
prices

Euro government bond indexes:
Euro Government Bond 10Yr Term Index (BCEX4T) From 2004 through 2016
Source:https://index.barcap.com/Benchmark_Indices/Government/Term_Indices/Euro_Govt_
10_yr_Term
S&P Eurozone Sovereign Bond Index since 2017, chain linked
Source:https://us.spindices.com/indices/fixed-income/sp-eurozone-sovereign-bond-index
Data is reported on sheet “BNCHM”




12
Social Security Code, art. 176 -178. In Bulgarian. http://noi.bg/images/bg/legislation/Codes/KCO.pdf
13
Financial Supervisory Commission. (2005). “Започва ежедневното поддържане на индекси за стойността на
един дял в пенсионните фондове, управлявани от пенсионноосигурителните дружества: PROFIDEX – за
професионалните, UNIDEX – за универсалните и VOLIDEX – за доброволните пенсионни фондове”.
https://bit.ly/2u7p9hl

11
Inflation:
Source:National Statistical Institute, Consumer Price Index, 1995=100, http://bit.ly/1vF95f7
Data is reported on sheet “CPI”.

12
 Appendix II - Methodology and Data

Nominal Returns:
Total Return (net of fees)
Gross Investor Return (net of fees)
Net Investor Return (gross of fees)

Real Returns:
Investor return (adjusted for inflation, gross of fees).

Total Return (net of fees)

Method: Time-weighted (geometric average) returns, calculated form pension funds
returned indexes:
UNIDEX – Universal funds unit price;
VOLIDEX – Voluntary funds unit price;
PROFIDEX – Professional funds unit price.

UNIDEX, VOLIDEX and PROFIDEX unit prices are modified weighted averages of the unit price
of each of the nine pension funds.

Data is reported on sheet “SUM”
Source: Financial Supervisory Commission, Unit values of pension funds
http://www4.fsc.bg/units.asp

Nominal Investor Return before/ after fees

Method: Internal Rate of Return (money weighted) calculation, based on the gross/ net
inflows from contributions, derived from the following indicators (aggregated by category of
pension fund – UPF, VPF, PPF)

Assets under management at the end of period data;
Contributions – quarterly data;
Gross outflows – quarterly data;
Pension funds revenue from fees and charges – quarterly data.

Calculations and adjustments:

Gross inflow from contributions: calculated by subtracting disbursements (outflows) from
inflows from contributions.

Net inflows from contributions: calculated as the difference between gross inflows from
contributions and the sum of gross outflows and pension funds’ revenue form fees and
charges.

Data is reported on sheets “UPF-Data”, “VPF-Data” and “PPF-Data”
Source: Financial Supervisory Commission, Pension Insurance Market Statistics

13
http://www.fsc.bg/bg/pazari/osiguritelen-pazar/statistika/statistika-i-analizi/

Real Investment Return (adjusted for inflation, gross of fees)

Method: Internal Rate of Return (money-weighted return) calculation, based on gross
contributions, adjusted for inflation.

Gross nominal contributions are inflated with the Consumer Price Index

Data is reported on sheet “CPI”
Source: National Statistical Institute, CPI, http://www.nsi.bg/en/content/6053/cpi-1995-100

Average Insurable Income for the Country

Data is reported on sheet “AII”
Source: National Social Security Institue, http://www.nssi.bg/forusers/infomaterials/135-
pensions

DATA and CALCULATIONS are reported in the Excel file “BG-PFC&PP-EN.xlsx”-https://bit.ly/2NBIpfH
KEY to the sheets
Sheets “BG FIG 1”, 2, 3 respectively – contain the figures in the text above
Sheet SUM contains summary calculations of Total and Investor Returns as well as pension
funds unit prices per year.
Sheet “Performance” reports calculations of Investor Returns for the three pension fund
categories – UPF, VPF and PPF
Sheet “Performance” contains data on unit prices per pension fund categories as well as
STOXX Europe index & Euro government Bond indexes and calculation of the Benchmark
portfolio – daily data.
Sheets “UPF-Data”, “VPF-Data” and ““PPF-Data” contain source data on pension funds’
assets under management, fees and cash flows as reported by the Financial Supervision
Commission – monthly data.
Sheet “CPI” contains monthly data on the Consumer price index as reported by the National
Statistical Institute
Sheet “AII” contains annual data on the Average Insurable Income (AII) and calculations of
the AII rates of growth (annual data)
Sheet “§4” contains data on transfers from PPF to the National Social Security Institute –
monthly data.

14
BIBLIOGRAPHY

Christoff, Lubomir, (2018). “Pension (In)adequacy in Bulgaria (2018 Edition)” (In Bulgarian, March 27, 2018).
Available at SSRN: https://ssrn.com/abstract=3150489

Dobbs Richard, Tim Koller, Susan Lund, Sree Ramaswamy, Jon Harris, Mekala Krishnan and Duncan Kauffman.
(2016). “DIMINISHING RETURNS: WHY INVESTORS MAY NEED TO LOWER THEIR EXPECTATIONS”, McKinsey &
Company https://www.mckinsey.com/industries/private-equity-and-principal-investors/our-insights/why-investors-
may-need-to-lower-their-sights

ESMA. (2017). “The impact of charges on mutual fund returns” in: ESMA Report on Trends, Risks and Vulnerabilities”,
No. 2.

European Commission. (2017). “REQUEST TO THE EUROPEAN SUPERVISORY AUTHORITIES TO REPORT ON THE COST
AND PAST PERFORMANCE OF THE MAIN CATEGORIES OF RETAIL INVESTMENT, INSURANCE AND PENSION PRODUCTS”
Ref. Ares(2017)5008790 - 13/10/2017) https://ec.europa.eu/info/sites/info/files/171013-request-to-esas-to-
report_en.pdf

Morningstar®. (2010). “Morningstar® Investor Return ™”. Morningstar methodology paper.
https://corporate.morningstar.com/us/documents/MethodologyDocuments/MethodologyPapers/InvestorReturnMeth
odology.pdf

Sit, Harry. (2012). Does The DALBAR Study Grossly Overstate The Behavior Gap? https://www.kitces.com/blog/does-
the-dalbar-study-grossly-overstate-the-behavior-gap-guest-post/

Social Security Code, art. 176 -178. In Bulgarian. http://noi.bg/images/bg/legislation/Codes/KCO.pdf

15