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INDIVIDUAL FUNDS IN AND HISTORICAL PROGRESS

Assoc. Prof. Dr. Turhan KORKMAZ Instructor Hasan UYGURTÜRK Zonguldak Karaelmas University, TURKEY Zonguldak Karaelmas University, TURKEY

ABSTRACT

Due to the deterioration of the effectiveness and productivity of social systems, a few important reforms related to plans have been initiated in Turkey, as all over the world. One of the important reforms is the Individual Retirement System (IRS). The IRS has been utilized in many countries for a long time; that it also accelerates the progress of pension funds. However pension funds alternatives were created in Turkey on October 27, 2003. There were many reasons why the application of IRS took a long time in Turkey, namely: high interest and inflation rates in the Turkish economy for many years, high level of public deficit, low confidence index, and high level of confidence on current social security system’s sufficiency. Since October 2003, Turkish pension funds have shown dramatic progress. As of December 2006 there are more than a million individual participants and pension funds market value has reached 1.7 billion dollars. All these improvements provide positive estimations for the next ten years. The projected numbers of Turkish pension funds are based on four million individual participants and reach over the 20 billion dollar fund value for the next decade.

Keywords: Social security, individual retirement, pension funds.

1 1. Introduction Community life style requires get others to support individuals when faces to risks. This solidarity establishes social security base and make its sustainability for years. The real function of the social security is to let people to feel strong confidence for the future. Tasks of well established social justice are to support poor people for minimum life standard and struggle with poverty. The good functioning of social security system requires well balanced financing. There are two fundamental financing techniques for funding of social security system, namely; a) distribution system and b) funding system. Distribution system is also known as “pay as you go”. In this financing technique, current income goes to current expenditures therefore there is no extra left for future to finance retired people’s needs. In the distribution system, increasing number of retired people to working people ratio creates payment difficulties (Ercan and Gökçe, 1998:42). The existing pay-as-you-go systems are condemned on both efficiency and distributional grounds. It is argued that these systems often lead to political promises of generous post-retirement benefits to workers, leading to high contributions or, as perceived by the workers, high . This in turn leads to evasion and switches to informal activities, various other labor market distortions resulting in lower overall , reduced output and lower labor supply. In addition, these are also thought to reduce economic growth from what it otherwise could be by failing to increase national savings or even reducing them (Singh, 1998:55). In the funding system and collecting enough reserve are required beforehand for the future expenditures. In this system collected funds are invested in productive, profitable and secure areas providing enough income for post-retirement expenditures (Ergenekon, 2001:89). This savings are formed and managed by individual or group funds. In the individual funding method, employees save money to pay premium in order to increase their income and enhance financial security during post-retirement years. Premium payments are customized by account holder’s marital status, age, income level, and other individual factors. Therefore there is a premium payment differences among the payers. These collected premiums in the fund will be used as a financial resource of individual insured payers’ social security income. In this system retired plans and retirement accounts are identified, financed and controlled by individuals. In the collective funding method, the social security institutions payments are collected in the mutual funds and these funds are used to pay account holders’ payments (Erol and Yıldırım, 2004:85). The objective of individual retirement system as in individual funding method is to complete missing part of the current social security system and provides additional income to individuals during post-retirement years (Ay and Çakıcı, 2002:58). 2. Individual Retirement System Populations in many countries turn into ageing trend. Both developed and developing countries’ social security regimes face with some problems such as; unstable active-passive equilibrium, increases of health service costs, economic instability, inflation, , tend to hire uninsured workers and etc. These kinds of undesired economic and social devlopments decreases of retirement utilities and forced to make an additional contribution from state budgets, increases premium and . These results reflect the reality of unsatisfactory and unfruitful social security system that is managed by the government authorities (Tuncay, 2002:4). Many countries all over the world have been experiencing serious problems in the social security system caused to get attentions of World , IMF, and OECD kind of

2 Institutions on this isssue. The research reports published by IMF (1987) and OECD (1988) indicate that public social security systems need to be reformed by the local lawmakers. In 1994 the World Bank declares to the world communities that democratic and liberal financing system should be included into the social security system (DPT 8. 5 Yıllık Kalkınma Planı: 70). The pension programme recommended by the World Bank’s report has a three-tiered structure. At its core is a defined contribution, fully funded, mandatory plan for each worker. This is supplemented by a public pension scheme of modest size with the “limited object” of alleviating poverty and co-insuring against a multitude of risks. The third tier of this system is a voluntary occupational or personal savings plan for those who want more income or insurance in their old age (Singh, 1998:56). In the private individual retirement system, individuals save their earnings during their active working times and to invest their earnings to the long-term financial to get better life or prevent life standard in the post-retirment period (Özbek, 2006:394). Being voluntarily, effective financing, and professional fund management are the most important mainstays of the individual retirement system.

Graph 1: Multi-Tiered Retirement System in the World

Source: www.garantiemeklilik.com/?aid=78, [Access Date: 15.11.2005]. From early 2000 till now, multi-tiered retirement system is progressed and spread all over the world. When we analyze the Graph 1, we can see the progress of multi-tiered retirement system. In 1985 less than 5 countries have multi-tiered retirement system, in 2000 more than 20 countries have multi-tiered retirement system and it is forecasted that more than 30 countries will have multi-tiered retirement system by 2010. All the new private pension systems that have followed the Chilean example have a simple structure where individual pension funds are managed by specialized financial institutions called administrators or a similar name (Yermo, 2000:2). Application dates of individual retirement system for some countries are given in the following Table 1.

Table 1: Application Dates of Individual Retirement System

Countries Year Chile 1980 England 1986 1992 Peru 1993

3 Colombia 1994 1994 1996 1997 Bolivia 1997 1998 1998 1998 1999 2003 Turkey 2003 2004 2004 Source: http://www.josepinera.com/icpr/pag/pag_ref.htm, [Access Date: 15.11.2006].

Unsatisfactory of current single-tiered retirement system and deterioration of system effectiveness tend to increase forecasted number of countries will apply individual retirement system. Therefore having individual retirement system creates pension funds that push incentives new financial instruments. These financial innovations help to develop capital markets and economy as a whole.

3. Private Pension Funds A fund established by an employer to facilitate and organize the of employees' retirement funds contributed by the employer and employees. The pension fund is a common pool meant to generate stable growth over the long term, and provide pensions for employees when they reach the end of their working years and commence retirement (Answers, 2007). In the private pension fund system, employees save some portion of their earnings and make regular payments during their active working periods for getting better life standard in their retirement ages (Erol and Yıldırım, 2004:151). Recently private pension funds attract more participants due to the people’s negative perception about traditional social security system. Serious threats and negative projections for the future payments are scared people and dropped confidence level to the traditional social security system. Therefore millions of participants pay premiums regularly that create opportunities to collect billions of dollars in the pension funds. These huge funds have been playing important role in the financial markets (Ergenekon, 1998:104). Fund managers create and offer different portfolios for different investors’ risk tolerances. One of the most vital problems facing society today is the increasing number and proportion of the population in the aged category. In 1910, there were only about 4 million people in the sixty-five and over range, whereas nearly sixty years later, the number had reached to 19.5 million in the . Aged population is growing approximately 400,000 per annum, it is estimated that there will be 35 million aged people by the year 2000 in the United States. The proportion of aged people more than doubled over the 1910-1969 period, going from 4.3 percent of the population to 9.6 percent. Present estimates place nearly 13 percent of the population in the sixty-five and older category by the year 2000 (Apilodo, 1972:398). The proportion of the population in the aged category in the US is similar to the other developed countries. Graph 2 illustrates the ratio of aged 65 over 15-64 in many developed countries.

4 Graph 2: The Ratio of Aged 65 over 15-64 in Many Developed Countries

Source: Ageing and Pension System Reform Implications for Financial Markets and Economic Policies, September 2005, p. 10, http://www.imf.org/external/np/g10/2005/pdf/092005.pdf, [Access Date: 15.11.2005].

Graph 2 indicates that the proportion of the population in the aged category has been increasing continuously. It is easily noticeable that this number will be double for and in 2050. Statistical results for the world, G10 and some developing countries are given in Table 2. Similar problems are noticed that developed countries have. Old-age (65+/15-64, in percent) is 11% in and 8% in India in 2005. It is forecasted that these numbers will be 37% in China and 22% in India by 2050. Similarly it is assumed that old-age dependency ratio will be increased 4% in the African Continent and 20% in the America. All these information lead to make a significant comment of old-age dependency ratio to the world population will be multiplied by 2.2 by the year of 2050.

Table 2: Old-age Dependency Ratios (65+/15-64, in percent) Year World G10 China Latin America India Africa 2005 11 23 11 9 8 6 2050 25 42 37 29 22 10 Source: Ageing and Pension System Reform Implications for Financial Markets and Economic Policies, September 2005, p. 58, http://www.imf.org/external/np/g10/2005/pdf/092005.pdf, [Access Date: 15.11.2005].

Current social security system needs to be reformed in many countries all over the world due to the increasing number of ageing population, increasing amount of health expenses, changing economic conditions and etc. Social security reforms are forced to create Individual Retirement System (IRS) and pension funds (mainstay of IRS). The concept of private pensions has a long history in the United States, with the first corporate pension plan established in 1875 by the American Express Company. After World

5 War II, the private pensions’ growth rate reached the maximum level in the United States. Following this expansion, the regulatory framework of the system was broadened and consolidated under the Employee Reirement Income Security Act-ERISA of 1974 (OECD, 1993:9). The first known private pension fund was established in 1375 in London, England. Association of Tradesman and Craftsman incorporated a private pension fund called “Guild of St. James at Garlekhithe of London” (Derelioğlu, 2001:17). As in the United States, England has also experienced the growth of private pension funds acceleration after the World War II. There are three main period of time for analyzing history of private pension funds progress. These periods are given as follows (Ergenekon, 2001:89): • 1900-1919: Heavily adapted and applied in social security system and private pension funds getting dominated • 1920-1949: During the period, the number of private pension funds has increased. • After 1950: After 1950, the numbers of private pension funds, the number of participants and asset values have been shown positive dramatic changes. The governments’ interests and incentives are the real reasons why private pension funds have been progressed in many countries after 1950s. The pension fund assets to GDP ratio in OECD has increased from 81.9% to 84.1% in 2004, driven by the growth of assets in the largest market, the United States. In the OECD area pension funds have grown drastically during the last decade. The dollar amount jumped from 5.9 trillion USD in 1994 to 15.6 trillion USD in 2004, representing 10.2% compounded rate of growth per annum (OECD, 2006).

Table 3: Total Value of Pension Funds in 2004 Countries Fund Value (Million dollar) USA 11,090,433 England 1,175,335 Japan 661,063 445,761 Australia 464,577 545,239 360,646 104,161 77,405 Italy 44,351 Denmark 73,095 Turkey 209 Source: Ceylan, Ali and Turhan Korkmaz, Sermaye Piyasası ve Menkul Değer Analizi, 3. Baskı, Ekin Kitabevi, Bursa, 2006, p. 161. The pension funds managers heavily invested in financial markets instruments. The primarily choices are , bonds, bills and international financial markets instruments. Increasing dollar amount in pension funds forced the fund managers to find new investment areas and new financial assets. Some pension funds managers invest directly in some companies equities. Some of the well known companies’ main shareholders are mutual funds and pension funds companies in the United States. These publicly traded companies are;

6 Philip Morris, Citibank, AOL Time Warner, American International Group, and Bank of America. For example, private pension funds invested 8% of Philip Morris shares, it worths more than 6.6 billion dollars. Deutchebank is an example for Germany. 21 German insurance companies invested more than 5% of Deutchebank shares (Ceylan and Korkmaz, 2006:162). 4. Individual Retirement System in Turkey and Historical Progress In Turkey the employees have to registar obligatory public social security institutions under the management and survelliance of government authorities. In addition to current social security institutions there are some social security complementary programs for widowed, orphan, and handicapped people in Turkey. There are also some unions and private pension funds which are organized by the specialized group try to support and filling the missing part of the current social security system. For example Amele Birliği (Workers Union), İlkokul Öğretmenleri Sağlık ve Sosyal Yardım Sandığı (ILKSAN- Primary School Teachers Health and Social Benevolent Society) ve Ordu Yardımlaşma Kurumu (OYAK- Armed Forces Pension Fund) are good examples. Yet these are not enough when consider the whole social security system. Amele Birliği (Workers Union) which is directly related to Ministry of Labor and Social Security was established in 1921 in Zonguldak. Management, operation and controls are done by its own written regulations (instructions). Amele Birliği has own its fiscal, admission and legistative autonomy. The aim of this social security institution is support the coal mining workers in the area of Zonguldak and Ereğli. ILKSAN is a social security institution that was established in 1943 as a General Directorate under the Ministery of Education. It is not an optional it is a mandatory to be a member for the primary school teachers. Its aim is to support its members to provide cash, build social facilities and teachers’ housing and increasing purchasing power in some ways (DPT 8. 5 Yıllık Kalkınma Planı:70). OYAK was established on March 1, 1961. It began offering members death, and retirement benefits and loans as a social service. In order to continuously develop its assistance and services, OYAK focused on investing its funds productively (OYAK, 2007). The insurance sector in Turkey mainly has begun to developed in the early 1990s. The 1990 regulation which liberalised the tariffs vitalised the insurance sector that experienced a rapid growth in Turkey. In fact, this sector generated, in 2004 a total 4,656 million USD in premiums, 891 million USD in the branch alone. On the other hand, its contribution to the economy in terms of indemnities totalled 2,776 million USD. There were, as of the end of 2004, a total of 47 insurance companies (40 private, 2 public and 5 foreign companies established in Turkey) operating in various branches. They include nine life insurance, ten life insurance and retirement, one retirement, 15 non-life insurance and 12 composite companies. There is only one reassurance firm in Turkey. Meanwhile, 15,632 insurance agencies, around 1,400 experts and 48 brokers operate throughout the country (BYEGM, 2007). As it is well known that almost all the developed countries have three steps social security systems. Turkey is a developing and candidate country to the Eurpoean Union full- membership tries to adapt developed countries’ social security systems. In August 1999, the “Individual Retirement Commisison” was constituted under the Ministry of Labor and Social Security. “Individual Retirement Savings and Investment System Bill” was sent to the Turkish Grand National Assembly on May 16, 2000. This is the first official step that has taken for individual retirement system in Turkey.

7 “Individual Retirement Savings and Investment System Bill” was evaluated by the Ministery of Finance, Ministry of Labor and Social Security, Treasury Undersecretariat and Capital Markets Board of Turkey experts. The final act was accepted on March 28, 2001 and issued in the official gazette on April 7, 2001. The act was activated after 6 months later on October 7, 2001 (bireyselemeklilik, 2006). The Individual Retirement System, complementing the public social security system, was introduced on October 27, 2003, with the objective of increasing the level of through additional income for the retired and contributing to economic development as well as employment opportunities through the creation of long term resources (BYEGM, 2007). There were many reasons why application of IRS takes long time in Turkey, namely; high interest and inflation rates, budget deficit, private pension funds are perceived unreliable, and high confidence on current social security system’s sufficiency (Ceylan and Korkmaz; 2006:163). After October 2003, Turkish pension funds have shown dramatic progress. As of December 2006 there are more than a million individual participants and pension funds market value reaches at 1.7 billion dollars. Currently, 11 retirement companies are engaged in the individual retirement system. The projected numbers of Turkish pension funds will be four million individual participants and reached amounted to 20 billion dollar fund value for the next decade. All these figures are steadily increasing as people choose individual retirement. There are many reasons why individual retirement system applied in Turkey in 2003. Bağ-Kur (Social Security Organization for Artisans and the Self-Employed), SSK (Social Security Institution) and Emekli Sandığı (Pension Fund) social security institutions do not provide enough satisfaction to its members and most of the time they request extra funds from the treasury department to financing its expenditures. Although the growth of birth rate relatively decreases through time, life span increases. Today’s young population will be retired in the future that means old-age dependency ratios (65+/15-64, in percent) will be increased. Currently there is an inequilibrium on active passive ratio, in the future ageing population will destroy active passive ratio deeply. All these problems pressured to initiate IRS in Turkey (Uğur, 2004:16). Moreover application of IRS creates private pension funds. Pension funds values and the numbers of account holders have been increasing day by day. These improvements have positive effects on capital market in Turkey. The main objectives of IRS are to play an important complementary role to the current social security system. Furthermore IRS motives individuals to save more money and invest long term capital market instruments to generate more income to have a better life standard during the post-retirement period. Particularly private pension funds are considered as a well established long term capital sources for the economy as a whole. Private pension funds help economic growth and lower unemployment rate (Erçoklu, 2002:138). In order to compare financial institutions among themselves, numbers of institutions, employee and branches are given in Table 4. As it is shown in the Table 4, there has been only 11 “Individual Retirement Institutions” operates in Turkey since 2004 till now. The number of employees is 7,163 in 2004 and has increased to 10,378 in 2005 but it stays stady in the third quarter of 2006.

Table 4: Number of Institutions, Employees and Branches in Turkish Financial Sector Number of Institutions Number of Employees Number of Branchs 2004 2005 2006 2004 2005 2006 2004 2005 2006 53 51 51 127.944 132.973 141.579 6.219 6.276 6.704 Leasing Corporations 82 84 83 987 1.146 1.285 4 4 5 Factoring Corporations 92 88 87 1.500 2.053 2.323 0 0 0 Consumer Financing 7 9 9 - 414 436 4 4 4 Corporations

8 Insurance Corporations 39 35 45 12.140 12.837 12.970 13.719 14.453 25.755 Individual Retirement 11 11 11 7.163 10.378 10.378 - - - Corporations Securities 23 26 31 Associations Securities Investments 154 149 146 5.906 5.916 6.057 224 234 238 Intermediary Institutions Real Estate Investment 9 10 10 Trusts Total 470 463 473 155.640 165.717 175.028 20.170 20.971 32.706 Source: Finansal Piyasalar Raporu, BDDK, Eylül 2006, S: 3, p. 24.

Table 5 shows the pension funds performances for the last 3 years in Turkey.

Table 5: Comparision of Pension Funds Performances No Pension Mutual Funds (PMF) 2004 2005 2006 1 Ak Emeklilik A.S. Flexible Growth PMF 26.19 30.65 13.15 2 Ak Emeklilik A. S. Gov't Bonds and Bills Income PMF 34.92 20.45 9.30 3 Ak Emeklilik A. S. Gov't Bonds and Bills (USD) Income PMF 2.81 5.00 14.13 4 Ak Emeklilik A. S. International Composite Income PMF 0.38 -9.07 11.05 5 Ak Emeklilik A. S. Composite Bonds and Bills (Euro) Income PMF 9.84 -9.24 18.91 6 Ak Emeklilik A. S. ISE 30 Index Specialized PMF 29.19 52.23 -2.20 7 Ak Emeklilik A. S. Gov't Bonds and Bills Liquid PMF 22.13 12.84 14.76 8 Anadolu Hayat ve Emeklilik A. S. International Composite Growth PMF 8.62 -0.99 17.33 9 Anadolu Hayat Emeklilik A.S. Flexible Growth PMF 32.17 41.08 21.09 10 Anadolu Hayat Emeklilik A. S. Growth PMF 19.85 59.17 8.43 11 Anadolu Hayat Emeklilik A.S. Flexible PMF 20.74 32.25 11.87 12 Anadolu Hayat Emeklilik A.S. Flexible Income PMF 27.66 16.63 13.58 13 Anadolu Hayat ve Emeklilik A. S. Gov't Bonds and Bills Income PMF 34.09 19.06 10.22 14 Anadolu Hayat ve Emeklilik A. S. Composite Bonds and Bills (USD) Income PMF 5.62 7.53 8.29 15 Anadolu Hayat Emeklilik A. S. Composite Bonds and Bills (Euro) Income PMF 9.30 -5.99 17.11 16 Anadolu Hayat ve Emeklilik A. S. Gov't Bonds and Bills Liquid PMF 19.91 12.27 14.29 17 Ankara Emeklilik A.S. Balanced PMF 19.88 27.74 5.31 18 Ankara Emeklilik A. S. Stock Income PMF 22.53 61.03 2.84 19 Ankara Emeklilik A. S. International Bonds and Bills Income PMF -6.47 -3.91 10.80 20 Ankara Emeklilik A. S. Gov't Bonds and Bills Income PMF 31.77 19.11 8.45 21 Ankara Emeklilik A. S. Gov't Bonds and Bills Liquid PMF 18.01 12.59 14.89 22 Hayat ve Emeklilik A.S. Balanced PMF 17.53 19.95 15.27 23 Aviva Hayat ve Emeklilik A.S. Flexible PMF 20.67 18.61 17.65 24 Aviva Hayat ve Emeklilik A. S. Gov't Bonds and Bills Income PMF 26.15 18.35 12.77 25 Aviva Hayat ve Emeklilik A. S. Gov't Eurobonds Income PMF 8.47 1.37 12.89 26 Aviva Hayat ve Emeklilik A. S. International Bonds and Bills Income PMF -7.07 -3.06 10.66 27 Aviva Hayat ve Emeklilik A. S. Gov't Bonds and Bills Liquid PMF 14.91 12.35 14.20 28 Başak Emeklilik A. S. Stock Growth PMF 30.53 42.09 2.39 29 Başak Emeklilik A.S. Flexible PMF 20.55 26.88 12.96 30 Başak Emeklilik A. S. Gov't Bonds and Bills Income PMF 32.16 18.65 12.09 31 Başak Emeklilik A. S. Gov't Bonds and Bills (FX) Income PMF 8.86 -3.62 13.64 32 Başak Emeklilik A. S. Gov't Bonds and Bills Liquid PMF 20.95 10.51 12.22

9 33 Fortis Emeklilik A.S. Flexible PMF 24.33 21.42 8.46 34 Fortis Emeklilik A. S. Gov't Bonds and Bills (FX) Income PMF 4.76 -0.27 12.84 35 Fortis Emeklilik A. S. FX Investment Instruments Income PMF 10.31 2.38 13.31 36 Fortis Emeklilik A. S. Gov't Bonds and Bills Income PMF 35.08 18.56 3.48 37 Fortis Emeklilik A. S. ISE 30 Index Specialized PMF 29.35 54.26 -3.23 38 Fortis Emeklilik A. S. Custody Composite Liquid PMF 15.52 7.07 12.09 39 Fortis Emeklilik A. S. Gov't Bonds and Bills Liquid PMF 21.39 12.04 14.64 40 Garanti Emeklilik ve Hayat A. S. Stock Growth PMF 23.46 52.60 3.97 41 Garanti Emeklilik ve Hayat A.S. Flexible PMF 25.00 31.49 5.31 42 Garanti Emeklilik ve Hayat A. S. Gov't Eurobond Income PMF 6.93 8.66 9.54 43 Garanti Emeklilik ve Hayat A. S. Gov't Bonds and Bills Income PMF 34.50 21.17 9.32 44 Garanti Emeklilik ve Hayat A. S. International Bonds and Bills Income PMF -0.28 0.97 7.21 45 Garanti Emeklilik ve Hayat A. S. Gov't Bonds and Bills Liquid PMF 20.61 12.73 14.98 46 Koc Allianz Hayat ve Emeklilik A.S. Flexible Growth PMF 18.50 25.18 5.62 47 Koc Allianz Hayat ve Emeklilik A. S. Gov't Bonds and Bills (FX) Income PMF 8.26 5.83 10.51 48 Koc Allianz Hayat ve Emeklilik A. S. Gov't Bonds and Bills Income PMF 41.11 20.27 7.02 49 Koc Allianz Hayat ve Emeklilik A. S. Gov't Eurobond Income PMF 14.73 9.79 7.46 50 Koc Allianz Hayat ve Emeklilik A. S. ISE 30 Index Specialized PMF 25.94 53.58 -2.97 51 Koc Allianz Hayat ve Emeklilik A. S. Gov't Bonds and Bills Custody Liquid PMF 12.89 9.20 13.56 52 Koc Allianz Hayat ve Emeklilik A. S. Gov't Bonds and Bills Liquid PMF 20.84 12.36 14.58 53 Koc Allianz Hayat ve Emeklilik A. S. International Flexible Income PMF 7.82 -0.64 20.62 54 Oyak Emeklilik A. S. Stock Growth PMF 25.35 38.20 8.56 55 Oyak Emeklilik A.S. Composite Growth PMF 25.67 25.84 17.35 56 Oyak Emeklilik A. S. FX Investment Instruments Income PMF 7.88 -4.15 10.95 57 Oyak Emeklilik A. S. Gov't Bonds and Bills Income PMF 24.92 19.54 9.46 58 Oyak Emeklilik Liquid PMF 20.40 13.43 15.19 59 Vakif Emeklilik A. S. Stock Growth PMF 22.09 62.31 3.03 60 Vakif Emeklilik A.S. Flexible PMF 28.54 20.48 12.37 61 Vakif Emeklilik A. S. Gov't Bonds and Bills Income PMF 23.49 18.61 9.09 62 Vakif Emeklilik ve Hayat A. S. Gov't Turkeurobond Income PMF 5.10 9.64 9.90 63 Vakif Emeklilik A. S. International Bonds and Bills Income PMF -1.66 -6.97 0.06 64 Vakif Emeklilik A. S. International Composite Income PMF 0.88 -9.66 0.45 65 Vakif Emeklilik A. S. Gov't Bonds and Bills Liquid PMF 17.40 11.51 14.28 66 Yapi Kredi Emeklilik A. S. Gov't Eurobond Income PMF 12.54 8.08 10.17 67 Yapi Kredi Emeklilik A. S. Stock Growth PMF 27.92 51.53 6.27 68 Yapi Kredi Emeklilik A.S. Flexible PMF 33.75 15.39 11.39 69 Yapi Kredi Emeklilik A. S. International Composite Income PMF 2.45 2.47 18.91 70 Yapi Kredi Emeklilik A. S. Gov't Bonds and Bills Income PMF 35.83 21.37 10.16 71 Yapi Kredi Emeklilik A. S. Gov't Bonds and Bills Liquid PMF 20.60 13.00 14.42 72 Yapi Kredi Emeklilik A. S. Gov't Bonds and Bills (FX) Income PMF 2.84 4.33 11.85 Source: http://www.fonbul.com/emeklilik/fon_tarih_getiriler.asp, [Access Date: 12.01.2007].

4.1. The Advantages of Individual Retirement One of the most important advantages of the individual retirement is considered as a transparent system. This transparency helps the account holders to follow and control his/her

10 mounthly payments, deductions, preferred fund distribution, and etc. Required and standard information about pension funds can be reached via internet or regular mail (Dağalp, 2001). Individulas risk tolerance could be change through time. Therefore individual retirement account holher is permitted to change his/her investment choices within the same pension company’s funds or retirement plans four times a year. Account holders are able to transfer their savings and accumulated rights to another pension companies. To do this, account holder has to stay at least one year in current pension company. Account holder can leave the pension company any time or hald monthly payments options are considered other advantages of the system. When the account holder gets the right to be retired in the system, there are some options to utilize his/her retirement account. The account holder can get lump-sum or some portion of the accumulated money. The other options are to receive monthly, quarterly, semi-annually or annually regular pay checks that is called “annual insured income” (Su, 2001). In order to get benefit from the system, account holders have to make monthly payment at least 10 years and cannot be retired till reach 56 years old. If account holder wants to close his/her account before 10 years up, he /she has to pay some penalty. There are many control and survelliance mechanism that increase the confidence to the system. Mainly Treasury Undersecretariat (Turkish Treasury Department), Pension Monitoring Center, Capital Markets Board, and Custody Bank and many institutions and organizations which their duties are regularly control the organizations in the system. Pension companies are also audited by independent auditing companies and internal auditing department as well.

4.2. How the System Works Participant, Pension Company and the written contract between them are the mainheart of the IRS in Turkey. These contracts give authoritization to the professional portfolio managers to manage pension funds in the name of participants. Takasbank (Custody Bank) is authorized as the Central Securities Depository (CSD) and is appointed as the National Numbering Agency of Turkey by the Capital Markets Board (CMB). With respect to CSD functions and responsibilities, Takasbank is regulated by the CMB (Takasbank, 2007). Fund assets are assuranced by the Custody Bank. Prime Ministry Undersecretariat of Treasury authorized the ‘Pension Monitoring Center’ (In Turkish ‘Emeklilik Gözetim Merkezi’ or in short EGM) in order to ensure that the Individual Pension System operates in a safe and efficient manner, and protects rights and interests of participants. As a self-regulated e- governance application, EGM is established to produce accurate information on behalf of Turkish Treasury for daily electronic monitoring of the companies operating in the system (EGM, 2007). Treasury Undersecretariat and Capital Markets Board of Turkey are to be authoritized to arrange the rules and regulations and forced to other institutions to obey the rules and supervise the system. Another important part of the system is Individual Pension Advisery Board that determines policies and gives advice how to apply the rules effectively (BES 2004 Gelişim Raporu: 22).

4.3. Pension Investment Funds in Turkey In the law of IRS Capital Markets Board gave permission only six different pension funds to operate. Namely; yield oriented funds, growth oriented funds, specializied funds, money market funds, precious metals funds, and other fund groups. For some reason one of the pension company does not able to continue its operation then it will be turn over to another pension company (Alper, 2002:26). Yield oriented pension funds targeted dividend and interest income while growth oriented pension funds targeted capital gains. Specialized pension funds focuse on geographic

11 region, country, industry, and indexes while money market funds focus on high level liqudation of financial assets which matures in 3 months or less. Precious metals funds include at least 80% of perious metal and gold backed securities. Pension funds’ operations have been initialized in October 2003. By then it has shown dramatic improvements. Table 6 shows brief results of pension funds progress from December 2003 to December 2006 in Turkey. Table 6: Pension Funds Progress

Number of Dollar Amount of Period Participants Invested Fund ($)

December 2003 15.245 3.989.177 December 2004 314.257 193.613.948 December 2005 672.696 755.872.756 December 2006 1.045.595 1.722.624.788 Source: http//www.egm.org.tr/BESgostergeler.asp, [Access Date: 15.12.2006]. As it is given in Table 6, there were 15.245 participants on December 2003. The number of partcicipants has folded 68.5 in three years and reached more than a million on December 2006. Dollar amount of funds value has folded 432. All these positive improvements support the forecasted number of 3-4 million participants and 20 billion dollars fund value in coming 10 years (Milliyet, 30.11.2006). Well established regulations and surveillances are the reasons why the pension funds show dramatic improvements in the last three years. The other important issue is tax incentives. The employees and the employers are able to get benefit from tax incentives. The employee has a right to deduct monthly pension payments up to 10% of monthly gross income from the taxable income. Tax deductable number cannot exceed total amount of minimum annually (Çakırsoy, 2005). Besides the employers can deduct the contribution part of the the employees payments from their taxable income. These tax deductions must not exceed the predetermined limit. If participant pay premium in 10 years but cancelled the contract before being 56 years old, 10% withholding tax will be applied to the total amount of the saving. If participant leave the system less than 10 years, 15% withholding tax will be applied. If participant lost his/her life, or disability occurs, the payments will be exempted 25% from , the rest of the amount is taxable just 5%. Cumulative life ’ money has transfered to the individual retirement accounts that’s why the pension funds have increased tremandously. As of October 7, 2006 423 million dollars has transferred from cumulative life insurances to individual retirment accounts. This amount is worth roughly 20% of individual retirment systems (Sabah, 30.10.2006). Even though there is a well established control system and regulation to prevent account holders to loss, but they still carry on investment risks. This risk is associated with economy as a whole and assets price risk in the seleceted funds. Pension funds managers are heavily invested in equities and treasurary bills, notes and bonds. This portfolio combination allows investors to utilizied risky and riskless assets. Generally treasury bills, notes and bonds are valued in terms of YTL (New Turkish Lira), along with Euro and USD. The aims of investing in treasury assets are to get maximum benefit, to protect investors’s savings from inflation, to get high return and secure cash flows in the future. Financial assets returns are expected higher than the inflation rate in the high inflationary economies. Otherwise the savings real value will depreciate.

12 Turkey has been struggling against high inflation rate for a long time. Particullarly after the economic crises in 2001 put a new economic reform into practice that causes to reduce inflation and interest rates through time. Table 7 illustrates (CPI) and alternative investment instruments returns from 1984 to 2004. Table 7: Investment Instruments Returns in Turkey (1984-2004) (%) Saving T-bill (%) Gold (%) ISE (%) USD (%) Mutual Funds Account (%) Year CPI Nominal Real Nominal Real Nominal Real Nominal Real Nominal Real Nominal Real 1984 48.4 42.9 -3.6 40.2 -5.4 15.8 -21.9 - - 62.8 9.7 - - 1985 45.0 50.6 3.8 49.6 3.2 24.0 -14.4 - - 42.0 -2.0 - - 1986 34.6 52.8 13.5 46.0 8.4 59.4 18.4 86.5 38.5 24.1 -7.7 - - 1987 38.9 49.0 7.3 41.0 2.2 55.8 12.2 295.8 184.9 27.8 -7.9 - - 1988 73.7 64.3 -5.3 61.4 -7.0 53.9 -11.3 -37.3 -63.9 66.0 -4.4 71.9 -1.0 1989 63.3 59.3 -2.4 58.9 -2.6 24.7 -23.6 511.2 274.3 49.2 -8.5 65.2 1.1 1990 60.3 53.9 -3.9 53.1 -4.4 3.6 -22.8 55.6 -2.9 22.9 -23.3 53.1 -4.2 1991 66.0 81.4 9.2 65.0 -0.6 51.4 -8.7 41.5 -14.7 59.9 -3.6 55.4 -6.3 1992 70.1 88.2 10.6 66.4 -2.1 56.5 -7.9 1.6 -40.2 65.1 -2.8 69.5 -0.2 1993 66.1 87.5 12.9 66.6 0.3 134.3 41.0 505.7 264.7 59.5 -3.9 83.1 10.2 1994 106.3 152.3 22.3 91.5 -7.1 152.9 22.5 44.9 -29.7 170.3 31.0 81.9 -11.8 1995 93.6 122.8 15.0 90.4 -1.6 29.9 -32.8 46.8 -24.1 54.0 -20.4 80.4 -6.8 1996 80.4 135.2 30.3 90.6 5.6 63.8 -9.1 143.8 35.1 75.4 -2.7 115.6 19.5 1997 85.7 109.7 12.5 86.8 0.6 47.9 -20.3 235.5 90.4 90.2 -2.4 91.0 2.8 1998 84.6 118.1 18.1 82.4 -1.5 53.5 -16.8 -24.7 -59.2 71.8 -6.9 64.1 -11.1 1999 64.9 108.4 26.3 75.2 6.2 74.6 5.9 485.3 354.9 60.5 2.6 136.0 43.1 2000 54.9 38.0 -10.9 38.0 -10.9 18.3 14.8 -37.9 -59.9 19.7 -22.7 20.8 -22.0 2001 54.4 96.2 27.0 60.0 3.6 118.7 41.6 46.0 -5.4 114.2 38.7 93.1 25.0 2002 45.0 64.0 13.7 51.5 4.4 40.1 -3.3 -24.7 -48.0 13.8 -21.5 37.9 -4.8 2003 25.3 45.5 15.9 31.0 4.6 2.2 -18.4 79.6 43.3 -15.4 -32.4 42.1 13.4 2004 10.6 26.6 14.4 22.7 10.9 2.0 -7.7 34.0 21.1 -4.0 -13.1 18.7 7.3 Compound Return % 771 102.6 33.2 871.9 25.4 142 Source: Yıldırım, Abdurrahman, http://www.sabah.com.tr, [Access Date: 04.01.2005]. Table 7 illustrates that from 1984 to 2004 ISE Index returns are the best among the investment alternatives in Turkey. Particullarly there were big return gaps between ISE Index and alternative financial instruments in 1987, 1989, 1993, 1997, and 1999. There was a huge devaluation in 1994 so Turkish Lira depriciated against USD. Therefore USD account holders gained 31% real return. However ISE Index has negative return due to the devaluation impact. As it is expected, the return volatility seems so much at ISE Index returns. Based on the historical results ISE Index is the riskier investment than the other alternatives. T-bill returns are much better than saving accounts for years. In order to compare three main investment instruments that pension funds have hefty investments. Graph 3 illustrates and concentrates only T-bill, ISE Index, and USD returns. T- bill performances were less than the inflation rate between 1988 to 1990 and 2000. Of the whole time interval T-bill compounded returns are calculated at 771%. Even though there was high inflation rates T-bill investments provided well expected returns for long time horizon. Thus pension funds managers’ oftenly consider investing T-bills for generate good fortune for their beneficiaries. It is also observed that the Turkish Lira’s volatility was low during the crawling peg period. In February 2001 the devaluation has occoured that leads to start free floating period. After February 2001 free floating period caused the volatility to increase. However high volatity did not continue for years and recently volatily became low. USD investors make 25.4% real returns during the 21 years.

13 Graph 3: Alternative Investments Returns and Inflation Rate

Graph 4 illustrates the performance of ISE National 100 Index returns from January 1991 to December 2006. Graph 4: ISE National 100 Index Performance (1991-2006)

Source: http://www.bigpara.com, [Acess Date: 16.12.2006]. As it is shown in Graph 4, ISE National 100 Index collapsed in the year of 2000 and 2001. Turkish economy has negative growth rate experience in 2000 and 2001. By then ISE has tended tremendous upward trend. Some pension’s funds have hefty investment in stocks that have shown high volatility but in the long run stocks provides comparable returns. As it is shown in Table 7 ISE Index compounded real return was 871% during the 21 years. That supports the idea of stocks are good investment alternatives for the long run. The same pattern was noticed for the Dow Jones Industrial Index return performance at New York Stock Exchange. Graph 5 illustrates the Dow Jones Index returns for the year 1987. On October 1987 the Dow Jones Index lost almost 40% of its value in less than one week.

14 Graph 5: Dow Jones Index Return in 1987

Source: http://www.besonline.net/disp.asp?oid=478, [Access Date: 16.12.2006].

Even though stock returns show high volatility and seems risky in short run, pensions funds are considered as long term institutional investors in the financial markets, previous performances has support the idea of stock index investments could provide good payoffs in the long run. As it is observed in Graph 6, scarely declines in 1987 did not last long and following 13 years almost 500% positive return has occoured for the Dow Jones Index in the United States. Garph 6: The Dow Jones Index Returns for the Year of 1987-2000

Source: http://www.besonline.net/disp.asp?oid=478, [Access Date: 16.12.2006]. There is a research to measure the performance of stock index performance during the 1926 to 2001. It is seleceted 20 years as a time interval to calculate annually arithmetic mean. The result was there was no lost, yet 12.5% annual return has observed (besonline, 2006). When any individual decide to open an IRS account, the individual risk profile determination test is applied. Based on the risk profile the best investment alternative is offered. Moreover pension fund’s account holders play an active role in the selection of portfolio.

15 New financial innovations and instruments will be necessarry while pension funds continue to progress and increase its portfolio values. Therefore pension funds play an important role for financial innovations and modernization in capital markets (Cansızlar, 2001). With all these positive improvements in the IRS in Turkey will be the major financial resources as is observed among the developed countries providing funds in the economy.

5. Conclusion

Even though IRS is an optional retirment plan shows dramatic progress for the last three years in Turkey. As of October 2006 there are more than one million pension funds account holders in the system. The total dollar amount is more than 1.5 billion that proofs the accelaration of growth rate. There are many contracts have been signed for the last three years and account holders cconntinue to transfer regular monthly payments that assures the system will have sustainable success in the future. The new government reform in the social security system which is called “Public Social Security Reform” tends to collect all the traditional social security institutions under the one umberrella. This reform emphasizes that current retirment system will offer less amont of money in the future when the current employee get retired. This creates the reallity of people will need second complementary social security. Furthermore this is an incentive and pressures for the current employees that are interested in individual retirement system in order to have a better life and better standards during their golden ages in the future. The system let free to enter individual and institutional participants. Therefore new incentives for institutional partcipations have been applied. This will contribute pension funds progress and somehow that has direct positive effect on Turkish economy. Pension funds investments will make capital market’s volume deeper that reduce speculative pressures and motivate more savings tendency and enhance long investment horizon. Pension funds will be the major player in the long terem market. Not only government but also private sectors get benefit from the long term borrowing potential. This investment climate helps Turkish sustainable economic growth and employement potential. Finally having some advantages should be supported by the new incentives and promoting the system to the potential participants that contributes to the progress of pension funds and economy as a whole in Turkey.

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