Universal Pension Fund Doverie. Statement of Investment Policy

Transcription

1 Universal Pension Fund Doverie Statement of Investment Policy

2 I. INVESTMENT POLICY AND INVESTMENT ACTIVITY FRAMEWORK 1. Levels of responsibility and the investment decision making process: а) the investment decision making process and the approval of the investment decisions, including the persons responsible for preparing the investment proposals and the investment analysis: The investment proposals regarding the assets of the Universal Pension Fund Doverie are prepared according to the law regulating the Pension Fund industry and according to the Managing Board approved investment policy statement of UPF Doverie for the respective periods. These proposals are subject to review by the Investment Committee(IC) which has a support function to both the Supervisory Board and the Managing Board of Pension Assurance Company Doverie AD. The investment proposals are prepared in a written format, saved electronically by the investment consultant, the portfolio managers or by the financial analysts of the company. The investment proposals have to be prepared according to the Rules on the Organization of activities of the Investment Committee with Pension Assurance Company Doverie AD. A two thirds majority of the Investment Committee members is required for passing the investment proposals (partially or in whole) as well as for rejecting the investment proposals. The investments proposals regarding investment properties are subject to approval by the Investment Committee, and once passed, are subject to further approval by the Managing Board of Pension Assurance Company Doverie AD. The members, the structure and the operations of the Investment Committee are subject of control by the Supervisory Board of Pension Assurance Company Doverie AD. б) execution control, the people who fulfill it and their roles and responsibilities: Prior to any trade execution, there is a double check procedure by the portfolio managers and/or the financial analysts regarding the complete conformity of the potential trade with all the internal and external rules and regulations regarding the Pension Industry. Further monitoring and control on a daily basis for qualitative and quantitative limits is performed by the portfolio managers and the investment analysts to make sure the investments are kept within the internal and regulatory limits. The responsibility for the legal and regulatory conformity and integrity of the investment proposals and the following investments is born by the portfolio managers and/or the investment analysts. 2

3 Post-execution control of the investment decisions is performed by the following structures and persons in the frame of their competence : through the Investment Committee of Pension Assurance Company Doverie AD by performing a review of the execution of the already taken decisions; through the Risk Management Department by performing a review of the execution of the already taken decisions; through the Internal Control Department by performing a review of the execution of the already taken decisions; through the Chairman of the Managing Board and the Executive Directors. The procedure of making investment proposals and then making investment decisions regarding the assets of the Universal Pension Fund Doverie, as well as the control on the execution process and the people charged with the control function are described in full details in The Internal Rules and Regulations of Pension Assurance Company Doverie AD concerning Investment Decision Making and Execution. 2. Investment Risk & Return measures including methods and frequency of their calculations. The measures used for the investment results are reviewed by the Investment Committee of Pension Assurance Company Doverie AD once every six months. Besides the below described measures, the Pension Company also uses the real return methodology according to the method of Internal Rate of Return, described in Part II, p.3 in this document. a) return Pension Assurance Company Doverie AD calculates the nominal return according to the methodology described in p.2 and p.3 from Attachment N4 announced on the FSC website Requirements regarding the materials used for advertisements and written information materials of the Pension Funds and Pension Assurance Companies according to article 123i, paragraph 2 and article 180, paragraph 2, p. 1 and p.2 from the Social Insurance Code. b) risk The investment risk of the portfolio of the fund is measured by the historical volatility captured in the standard deviation of the return according to the methodology described in p. 4-7 from Attachment N4 published on the FSC website Requirements regarding the materials used for advertisements and written information materials of the Pension Funds and Pension Assurance Companies according to article 123i, paragraph 2 and article 180, paragraph 2, p. 1 and p.2 from the Social Insurance Code. c) risk-adjusted return 3

4 Pension Assurance Company Doverie AD determines the risk-adjusted return of the fund through the Sharp ratio, calculated according to the methodology described in p.8 and p.9 from Attachment N4 published on the FSC website Requirements regarding the materials used for advertisements and written information materials of the Pension Funds and Pension Assurance Companies according to article 123i, paragraph 2 and article 180, paragraph 2, p. 1 and p.2 from the Social Insurance Code. 3. Trade execution rules and a limit on the portfolio turnover Trade execution is performed according to the Internal rules and procedures of Pension Assurance Company Doverie AD for decision taking and their technical execution and by observing the legislation. Upon trade execution, the portfolio managers and/or the financial analysts have the responsibility to take good care to optimize the total trade volume and aggregate trades where possible for the purpose of reducing the transaction costs. This way the portfolio turnover will be optimized. Increased trade volume is acceptable only in the case of liquidation of risky exposures or realizing positive return, which return must more than offset the transaction costs. 4. Rules for determining and monitoring of the current liquidity needs. The current liquidity needs are determined on a monthly basis. The key inputs in its determination are the expected by cash inflows and outflows related to the investment activity of the Universal Pension Fund Doverie, possible changes in the legislation as well as by the expected payments related to the fund beneficiaries or their inheritors. 5. The policy the PAC Doverie AD follows upon the execution of the rights of the fund as a sole owner of the securities. Pension Assurance Company Doverie AD in its role as the manager of the assets of Universal Pension Fund Doverie, executes all legal and contractual rights granted to the Universal Pension Fund Doverie in its role as the owner of the securities thus protecting the interests of the fund beneficiaries. Representatives of UPF Doverie have the right to participate in shareholder and bondholder meetings of the issuers and to vote at these meeting only in the interest of the UPF fund beneficiaries taking into account both the immediate effects as well as the future effects. 6. Investment results announcement frequency and the method of presenting Following valuation of the assets and the liabilities of the Universal Pension Fund Doverie is performed on a daily basis according to the approved from FSC Rules for valuation of the assets and the liabilities of Pension Assurance Company Doverie and its managed funds of supplementary pension assurance. On a daily basis, there is a calculation of the accounting value of one unit of UPF Doverie, which is published on the web site of PAC Doverie AD and the web site of the FSC. 4

5 PAC Doverie AD makes public announcement of the data related directly or indirectly to the investment results of the Universal Pension Fund Doverie keeping strictly to the requirements regarding the materials used for advertisements and written information materials of the Pension Funds and Pension Assurance Companies according to article 123i, paragraph 2 and article 180, paragraph 2, p. 1 and p.2 from the Social Insurance Code. II. DEFINITION OF THE INVESTMENT OBJECTIVES 1. Return Objectives: The main objective of the investment policy of Universal Pension Fund Doverie is to preserve and increase in real terms the supplementary pension savings of the fund members in the medium and longer run through achieving the highest rate of return possible while assuming moderate risk exposure. 2. Risk Objectives: The Fund shall achieve its investment objective following a balanced investment policy and undertaking moderate risk. a) time horizon restrictions: Since the liabilities of Universal Pension Fund Doverie are long- term, the time horizon of the portfolio is relatively long term more than 20 years. b) liquidity requirements: The long- term character of member savings in the Universal Pension Fund Doverie, the increasing fund membership and pension fund contributions, the low average age and the relatively small number of occasions leading to withdrawal of the accumulated resources, lead to higher cash inflows into the fund compared to the outflows and therefore currently low liquidity needs. c) other requirements: Investment returns on the portfolio of Universal Pension Fund Doverie are exempt from corporate taxes and the return distributed to member accounts exempt from income tax. 3. Criteria for investment policy objective achievement. Indicator for investment policy results juxtaposition The objective managing the supplementary pension saving of the fund members is to preserve and increase in real terms the purchasing power in a long run. The indicator for preserving the purchasing power of Universal Pension Fund Doverie is considered 5

6 Real Return in percentage points of the managed funds of Universal Pension Fund Doverie using the method of internal rate of return (money weighted rate of return). The calculation is done on monthly basis for the period under review. The aim is reaching positive real rate return of 0.25% YoY for the last 5 years. Calculating the Real Rate of Return is done as follows: n number of months in the reported period А0 net assets of the fund in the beginning of the period; Аn - net assets of the fund in the end of the period; I0 CPI for the month before the first month of the reported period; Ii CPI of month i, where 1 < i < n-1 In CPI of the last month of reported period; Fi Net cash flow for month i, where Fi=Gi-Mi-Ni, for i: 1 < i < n-1; Gi gross amount of member contributions for month i, including transferred contribution from other pension funds; Mi paid amount to members for month i, including transferred contributions to other pension funds; Ni charged and paid fees to PAC Doverie AD for the contributions in month i; F0 = А0 and Fn = -Аn+ Gn-Mn-Nn Rr YoY Real rate of return for the period, where: where di is number of days from the beginning of the reported period till the last day of month i of the period, where d0 = 0. III. DESCRIPTION OF THE INVESTMENT POLICY FOR ACHIEVING THE INVESTMENT OBJECTIVES 1. Investment policy rationale- determinant factors and circumstances: The Investment Policy Statement is consistent with the specifics and requirements for conducting supplementary pension assurance in Bulgaria. The complexities of pension fund portfolio management increase the importance of establishing a well- defined and effective investment policy that clearly defines the investment objectives and constraints. 2. Specific requirements regarding asset classes characteristics. The governing bodies of PAC Doverie AD approve a list of the specific characteristics of the asset classes in which Universal Pension Fund Doverie invests. 6

7 The list is presented as Appendix 1 to the Investment Policy Statement and is an integral part of it. 3. Investments: a) legally approved investment instruments, asset classes and type of limits: The governing bodies of PAC Doverie AD approve a list of the legally allowed investment instruments, and the asset classes and types of limits which apply to the investments of Universal Pension Fund Doverie. The regulations are systemized in Appendix 2, which is an integral part of the Investment Policy Statement. b) geographical regions and markets allocation: The portfolio allocation by geographical regions and markets is part of the diversification policy of Universal Pension Fund Doverie, aiming to optimize risk and return. Its implementation is regulated by Ordinance 29 on the minimum level of credit ratings on banks and the definition of the countries, regulated markets and securities regulated markets indexes under Art. 176 of the Social Insurance Code.. Depending on market conditions and perspectives, investment can be allocated to each of the legally approved geographical regions and regulated markets. c) sector diversification: Considering the economic cycles and the general and systematic risks the fund strives to allocate its funds to the economic sectors that are expected to generate highest rates of return. Due to the dynamic market environment, sector limitations or restrictions do not apply. The major economic sectors are: Energy Materials Industrials Consumer Staples Consumer Discretionary Health Care Financials IT Telecommunication Utilities 4. Investment restrictions and limits. The restrictions and limits that apply to the fund s investments are legally determined and systemized in Appendix 2 to the Investment Policy Statement. The assets of Universal Pension Fund Doverie may not be invested in: 1. securities which are not fully paid up; 7

8 2. securities issued by the pension insurance company which manages the fund or by persons related to it. 3. securities issued by the custodian bank, by entities under art. 123c, para 1 of the Social Insurance Code, or parties related thereto. 5. Target strategic asset allocation, minimum and maximum deviation limits: The target strategic asset allocation of the fund s portfolio provides the asset class weightings that, considering the return and volatility expectations for each one of them, would be most appropriate for achieving the fund s investment objective. The asset class allocation provides diversification and optimizes the risk/ return balance. The selection of each specific financial instrument to be used depends on the market conditions, its unique characteristics, and its expected contribution to the structure, risk, and return of the investment portfolio. Deviations from the target strategic asset allocation are permissible in any moment and can be result of the active portfolio management in the context of the market environment and the relative attractiveness of the investment alternatives, significant deviations in the market prices of the portfolio assets and/ or significant cash flows from the fund s operations. The target strategic asset allocation and the minimum and maximum deviation limits are presented in Appendix 3, which is an integral part of the Investment Policy Statement. 6. Diversification by asset classes. The asset class allocation and instrument selection processes seek to optimize the investment portfolio diversification and maximizes its protection against adverse markets movements and significant exposures to individual market sector, geographical region, economic sector, a single company, or security issue. 7. Specific investment strategies and styles. The investment portfolio of Universal Pension Fund Doverie is actively managed as its structure is subject to changes depending on the market conditions and the relative attractiveness of the different types of asset classes. Due to markets dynamics no style restrictions or limitations apply. 8. Investments in collective investment schemes. The purpose in including collective investment schemes in the investment portfolio is to achieve higher degree of diversification and improve liquidity while optimizing the fund s costs. In the selection process, a set of criteria is considered, including: portfolio diversification, risks related to the specific investment goal, historical performance relative to the product s benchmark, credit and reputation risk of the product s provider, liquidity, and management costs. 8

9 9. Degree of underinvestment. PAC Doverie AD analyzes the liquidity needs of Universal Pension Fund Doverie using data on historical cash inflows and outflows and prepares a monthly forecast for the fund s flows from operations. Based on the analysis PAC Doverie AD sets a minimum threshold of cash and equivalents to be maintained in the portfolio. Deviation between minimum and maximum threshold for cash and cash equivalents outlined in Appendix 3, is permissible in any moment and can be a result of the active portfolio management in the context of the market environment and the relative attractiveness of the investment alternatives. ІV. INVESTMENT RISKS AND RISK MANAGEMENT 1. Identification of the investment risks. PAC Doverie AD identifies, measures and monitors all risks, associated with the company's activities and the various types of securities in the portfolios of the managed suppementary pension assurance funds, as described below: 1) Market risk - the possibility to be generated losses due to adverse changes in the prices of the securities, market interest rates, exchange rates and other. The major types of market risk are: а) Interest rate risk - the risk of decrease of the value of the investment in a given security by reason of change in the level of the interest rates. b) Exchange rate risk - the risk of decrease of the value of the investment in a given security or deposit, denominated in a currency, different from Lev and Euro, by reason of change in the exchange rate between this currency and the Lev or the Euro. c) Price risk, associated with the investments in shares or other equity securities - the risk of decrease of the value of the investment in certain security in case of adverse changes in the levels of the market prices. d) Price risk, associated with the investments in investment property - the risk of decrease of the value of the investment in investment property due to adverse changes in the levels of the market prices. 2) Risk, associated with the possibility of the hedging instrument to stop performing its purpose for reduction of the investment risk, related to a specific asset of the Fund. 3) Credit risk is generally the risk of decrease of the value of the investment in a given security due to unexpected credit events, related to the issuers of financial instruments, the counterparty on exchange and over-the-counter transactions, as well as the countries in which they perform activity. PAC Doverie AD identifies three main types of credit risk: 9

10 а) Counterparty risk - the risk of non-performance of the counterparty's obligation on over-the-counter transactions, such as forward exchange contracts, interest swap contracts etc. b) Settlement risk - the risk, arising from the possibility of not receiving contrary cash or financial instruments from counterparty on the settlement date, after the Fund had fulfilled its obligations on certain transactions. c) Investment credit risk - the risk of decrease of the value of the investment in certain debt securities by reason of credit event with the issuer of this instrument. Credit event shall include adjudication in bankruptcy, insolvency, significant change in the capital structure, credit rating downgrade etc. 4) Operational risk - the risk of direct or indirect losses, resulting from inadequate or inoperative internal procedures and systems, actions or inactions of employees or events, occurred due to external factors. 5) Liquidity risk - the possibility of losses caused by urgent sales of assets at unfavorable market conditions to meet unexpected short-term liabilities or the inability to buy/sell certain asset due to lack of supply/demand. 6) Legal risk refers to the risk for the portfolios, related to unexpected changes in the Social Insurance Code or other regulations, followed by PAC Doverie AD and the pension insurance funds, managed by it. 7) Reputational risk is the risk of losses, arising from damaged reputation as a result of negative publications and statements by various counterparties (competitors, clients, shareholders and others) in mass media, electronic media and others, concerning PAC Doverie AD and the pension insurance funds, managed by it. 8) Risks, relevant to the hedging instruments а) Market risk of the hedging instruments - the risk of change in the value of the hedging instruments, resulting from changes in the interest rates, the prices of the underlying securities, indices or foreign exchange rates.. The market risk of the hedging instruments is considered on portfolio basis, taking into account the investment position being hedged. b) Credit risk - the risk of potential failure of the counterparty on a hedging deal to fulfill their obligation on the settlement date of the forward exchange contract or the interest rate swap contract. c) Liquidity risk is the risk for certain pension insurance fund to be unable to take or liquidate a hedging position, without significant negative impact on the value of the hedging instrument. 10

11 d) Basis risk in futures contracts - it occurs when the characteristics of the futures contract differ from those of the position, being hedged. Basis risk is the uncertainty whether the spread between the spot price and the futures price will increase or decrease during the period of the hedging contract. e) Operational risk arises when PAC Doverie AD fails to undertake the necessary actions as a result of imperfections in the system of organization, internal control, information technologies, human errors or inadequate procedures. 2. Methods of Risk Assessment of individual investments and on a portfolio level. 1) PAC Doverie AD measures the interest rate risk of the assets through the following quantitative methods: а) Duration is the main measure for interest rate sensitivity of a particular security. PAC Doverie AD shall use the method of the modified duration to measure the interest rate risk, related to each security, based on an interest rate such as bonds, interest rate swaps, futures, based on interest rates and futures, based on bonds. b) The modified duration shall be calculated using the following formula: Мodified Duration = Duration (D) / (1 + r), (( t D m (( tc ) /((1 ) ))) /( t 1 t r t 1 where: r = yield to maturity Ct = cash flow at the moment "t" m = maturity in years t = time in years until the Ct will be received m (( C t ) /((1 r) t )))) 2) PAC Doverie AD measures the exchange rate risk of the assets through quantifying the net exposure to each currency, different from Lev and Euro, as a percent of the total assets of the pension insurance fund. 3) PAC Doverie AD measures the price risk, associated with the investments in shares through one of the quantitative methods, applicable for the respective securities market: а) Historical volatility, measured by standard deviation; b) β-coefficient to the indexes of the respective market; c) In case of impossibility for application of items a) and b), PAC Doverie AD shall use standard deviation of the chosen index of the regulated market in accordance with 11

12 Ordinance 29/ , on which the particular shares are traded as a substitute in the complete analysis of the portfolios. 4) PAC Doverie AD measures the price risk, associated with the investments in property trough monitoring key parameters and trends of the real estate market in Bulgaria in all its segments. For the purpose of risk assessment, the Fund takes into account the specifics of each property, analyzing the following factors: а) type of the investment property; b) stages of the life cycle of the property; c) location of the property; d) economic condition in the subsector, in which the property falls. 5) PAC Doverie AD measures the counterparty credit risk on a daily basis by calculating the value of the unearned profit from the concluded forward exchange contract or the interest rate swap contract. In determining the value of the unearned profit under the fees and commissions paid on the conclusion of such transactions shall not be taken into account. Where the fund has hedging instruments on several transactions with one and the same counter-party, the value of the risk of default on the obligations by the counter-party to these transactions equals the difference between unearned profits and losses from all such transactions where: а) the transactions are concluded on the basis of a netting agreement with the counterparty; b) the netting agreement under item a) provides for that in case of default, bankruptcy or liquidation of the counter-party to the transaction only one liability (in case of net negative market value) or one receivable (in case of net positive market value) to the fund shall be calculated, whereby the receivables and liabilities subject of the netting agreement shall be deemed settled;; c) the insolvency of the counterparty is a ground for termination of the contract. 6) PAC Doverie AD measures the settlement risk by calculating the value of all unsettled transactions with one counterparty as a percent of the assets of the pension fund. The transactions concluded upon conditions of settlement DVP (delivery versus payment) and on markets with functioning clearing mechanism, shall not be taken into account. 7) For the purpose of credit risk management PAC Doverie AD accomplishes qualitative and quantitative credit analysis based on: а) financial statements of the issuer; b) capital structure of the issuer; c) collateral of the issue, if the issue is secured; 12

13 d) management and reputation of the issuer. 8) Operational risk assessment and analysis is accomplished through quality measures, based on analysis of the employees, the business processes, models and technological base of the Company. For the purpose of identification and classification of the operational risks, the Risk Management Department establishes internal categorisation system for operational events, their significance and likelhood of occurence. 9) PAC Doverie AD shall measure and analyse the liquidity risk of the fund on the base of the historical data for the incoming and outgoing cash flows and the monthly forecast for the cash flows, related to the activities of each of the funds. Based on this analysis PAC Doverie AD sets a minimum threshold of cash and cash equivalents in the portfolio. 10) PAC Doverie AD shall analyse and monitor the legal risk through monitoring for potential changes and determining the probability of changes in the legislation and creates conditions for taking adequate measures to avoid losses of such changes. 11) PAC Doverie AD shall analyse and monitor the reputational risk by performing qualitative analysis of events, bearing reputational risk, which may result in a reduction of the customer base, reduce revenues or other negative consequences. 12) The Company measures the market and credit risk of the hedging instruments through the following methods: а) potential change in the value of the interest rate futures contracts - -shall be measured through the modified duration of the underlying asset (cheapest-to-deliver bond) on the maturity date of the futures contract, i.е: f Df r, where: f change in the value of the futures contract; D modified duration, calculated in accordance with p. 2.1.b); f value of the futures contract; r change in the interest rate. b) market risk of the futures, based on stock indices shall be measured through: b1) historical volatility, measured by standard deviation: where: n t 1 ( r r) t n

14 - standard deviation of the rate of return on an annual basis (continuously compounded) of the market index (the underlying asset); rt - rate of return for the period; n number of periods; r - average rate of return for period " t ". b2) β of the futures contract. As the underlying asset of the futures contract is a market index, it is generally assumed that β of the futures contract is equal to 1 or β shall be calculated as follows: Covfi 2 i where: Cov fi - covariance between the underlying asset and the market index; σ standard deviation of the market index. c) the impact of the change in the price of the underlying asset on the value of the option is measured by "delta". Delta of a call option shall be calculated, using the formula: Delta Nd 1 Delta of a put option shall be calculated, using the formula: Delta N d 1 1 where: Xr T d ln( /S)( )2/ T S 0 current price of the underlying asset; N(d) the probability of a random observation on the standard normal distribution to be equal to a number less than "d". The corresponding values can be found in the normal distribution tables; X strike price of the option; r risk-free interest rate; T time to maturity of the option /in years/; ln natural logarithm function; - standard deviation of the return of the underlying asset (volatility). d) the impact of the change in the interest rates on the value of the interest rate swap contracts is calculated, using the duration of the swap contract, which is determined by decomposing of the swap contract into long (short) position in a floating rate bond and 14

15 short (long) position in a fixed rate bond. Duration shall be calculated by using the formula specified in Part IV, p. 2.1).b) of this document. e) the credit risk of the forward exchange contracts is measured by the value of the contract for the fund, in case it is positive. f) the credit risk of the interest rate swaps is measured by the value of the contract for the fund, in case it is positive g) the hedging instruments (futures and options), traded on a regulated market aren't exposed to credit risk because of the clearing house participation which serves as an intermediary and the daily margin requirements rules. 13) the market risk of the entire portfolio of the fund is measured by standard deviation, calculated according to the methodology, specified in Part I, p.2.b) of this document. 3. Risk profile of the portfolio. PAC "Doverie" AD maintains moderate level of risk, corresponding to the investment objectives of risk and return of UPF Doverie. 4. Rules and procedures for monitoring, evaluation, and control of the investment risk. Techniques and strategies for risk management. 1) The Risk Management Department of PAC Doverie AD is under the direct supervision of the Managing Board and consists of the Head of Risk Management Department and Risk Management experts. If necessary, external Risk Management consultants could be hired. 2) The Risk Management Department monitors the risks, described in Part IV, 1 at portfolio level and coordinates and reports these exposures according to the requirements in the Social Insurance Code, the Statement of Investment Policy and the market conditions. 3) The Risk Management Department constantly monitors and controls the risks associated with the investment management process, the risk of the hedging instruments and their effectiveness, as well as the overall investment portfolio risk. 4) The Risk Management Department prepares risk evaluation analyses and reports, proposals for internal limits and restrictions for the purposes of risk management, and proposes measures for risk limitation. 5) The Head of the Risk Management Department reviews the quantitative indicators for the market risk of the portfolio on a monthly basis and makes assessment whether the level of market risk matches the investment objectives, outlined in the Statement of Investment Policy, as well as the market conditions. 15

16 6) When the Head of the Risk Management Department makes an assessment that a certain market risk is above the tolerance level for this type of risk, associated with the risk profile of the fund, he reports to the Chairman of the Managing Board and to the Executive Director of PAC Doverie AD, supervising the Finance, Accounting and Investments Department. The later addresses the portfolio managers with request to prepare a written proposal for hedging transaction(s) in accordance to Art.4 and Art. 5 from Ordinance 34. 7) The Head of the Risk Management Department prepares an analysis on the effect of the hedging transactions over the fund s risk profile, while monitoring the effectiveness of the hedging transactions, and reports the results to the Investment Committee on a monthly basis. 8) For managing the appraisal risk related to the investments in real estate, a monitoring report of the properties is prepared and presented to the Investment Committee of PAC Doverie AD at least once a year. The report analyzes the real estate s current condition, effectiveness, market trends and the inherent risks, associated with this type of investments. 9) For the purpose of operational risk management, the Heads of Departments, related directly or indirectly to the investment process of the fund, collect information about errors, omissions and other events that could lead to direct or indirect losses, and present this information to the Risk Management Department. 10) Based on the analysis of the above operational risk events and their consequences the Head of the Risk Management Department could propose to the Chairman of the Managing Board and to the Executive Director of PAC Doverie AD, supervising the Finance, Accounting and Investments Department to enact a series of measures aiming to limit the operational risk. 11) The specialized Internal Control Department conducts tests and checks of the risk monitoring, evaluation and management system and reports to the Investment Committee of PAC Doverie AD in case it ascertains a problem. 12) In case of breaching the internal limits and regulations as well as the investment limits of the Social Insurance Code, the Head of the Risk Management Department or the specialized Internal Control Department immediately informs the Chairman of the Managing Board and the Executive Director of PAC Doverie AD, supervising the Finance, Accounting and Investments Department, for the violation and the reasons for its occurrence. Depending on the type and nature of the breaching, the Head of the Risk Management Department and/ or the specialized Internal Control Department prepare a proposal for correction of the violation, which should be approved by the Management of PAC Doverie AD. 16

17 13) The management process of the portfolio of PAC Doverie AD complies with the internal rules determining the procedures for monitoring, evaluation and management of risk, as well as Rules on the Organization of activities of the Investment Committee with Pension Assurance Company Doverie AD. These Rules lay out the organizational structure and the levels of supervision and responsibility associated with the risk management process in the Company and aim to ensure the daily monitoring, evaluation and management of the risk factors that have a negative influence on the value of the assets in the portfolio managed by PAC Doverie AD. 5. Hedging transactions - purposes of use, types of transactions, risks to be hedged, amount of the risk exposure. Degree of hedging of the risks, associated with the Fund's investments 1) Hedging transactions - purposes of usage and types of transactions PAC "Doverie" AD may enter into hedging transactions under Art. 179b para. 1 of the Social Insurance Code / SIC / from and on behalf of the Fund only for the purpose of reducing the investment risks, related to the fund's assets. 2) Risks, subject to hedging The risks, described in Part IV, p.1, 1) and p.1, 3) can be reduced by hedging transactions. 3) Size of the risk exposure The size of the risk exposure subject to hedging shall be determined by the Risk Management Department, after a detailed analysis of the portfolio, taking into account all the factors associated with the current market conditions. 4) Degree of hedging of the investment risks The degree of hedging of a specific investment risk shall be determined on the basis of analysis of the Fund's exposure to this risk, the current market conditions and the potential quantitative impact of a particular hedging transaction, respectively unhedged position on the fund's portfolio. V. STIPULATION, PERIODICITY AND TERMS FOR INVESTMENT POLICY REVIEW 1. Investment policy effectiveness assessment 17

18 Investment policy effectiveness assessment is done by the indicator defined in chapter II Para 3 every 6 months. In case the return of the UPF Doverie portfolio is lower then the indicator defined in chapter II Para 3 for two following 6 months periods, the investment consultant, portfolio managers and/or financial analysts should present to the Investment Committee of PAC Doverie AD a detailed analysis of the reasons for shortfall and strategy and proposed measures for investment policy objective achievement. 2. Procedures and criteria for Investment policy review. Review of the Investment policy regarding the managing principles of UPF Doverie is done by the Investment Committee every 3 years or immediately after any major changes in financial and market environment. 3. Procedures for implementation of changes in Investment policy/strategy Once Investment policy effectiveness assessment is done as described in Chapter V Paragraph 1 and if it is considered that any changes in investment strategy/policy might be necessary, the investment consultant, portfolio managers and/or financial analysts prepare motivated proposal to the. Investment Committee Once approved by the Investment Committee the changes in the investment policy/strategy of UPF Doverie are subject to further approval by the Managing Board of PAC "Doverie" AD. 18

19 Appendix 1 Specific Requirements Regarding Asset Classes Characteristics state. legal entity. 1. Government bonds - fixed income securities issued and guaranteed by a 2. Corporate bonds - fixed income securities issued and guaranteed by a 3. Mortgage bonds - fixed income securities issued and guaranteed by a bank and backed by payments on mortgage loans. municipality. ownership. 4. Municipal bonds - fixed income securities issued and guaranteed by a 5. Common stocks - securities representing the right of corporate equity 6. Collective investment schemes - investment vehicles, organized as open- end funds, exchange traded funds or investment trusts, which invest in securities, money market instruments, and other liquid financial assets, the money raised through public offering of units or shares. 7. Special investment purpose companies - investment companies securitizing real estate properties or receivables. 8. Deposits cash funds placed for safekeeping in credit institutions and subject to return to the depositor under predefined terms and conditions. 19

20 Appendix 2 Universal Pension Funds Instrument Limits Notes 1. Government debt no limit no limit 2. Securities traded on regulated markets 2.1. Corporate bonds up to 25% 2.2. Equity up to 20% up to 5% in the securities (bonds & equity) of a single issuer a) up to 5% in the securities (bonds & equity) of a single issuer b) cannot aquire more than 7% of the shares of a single issuer 3. Municipal bonds up to 15% up to 5% in the securities of a single issuer 4. Bank deposits up to 25% 5. Mortgage bonds up to 30% a) in banks with credit rating; b) total exposure to one bank (including bond issues and repurchase agreement) up to 5% a) should be traded on regulated markets; b) up to 5% in the securities (bonds & equity) of a single issuer 5. Infrastructure bonds up to 10% 6. Real estate up to 5% 7. Special Investment Purpose Companies 8. Secured corporate bonds to be listed within 6 months up to 5% up to 5% a) up to 5% in the securities (bonds & equity) of a single issuer b) cannot aquire more than 7% of the shares of a single issuer up to 5% in the securities (bonds & equity) of a single issuer 9. Mutual funds up to 15% up to 5% in mutual funds managed by a single asset management company 10. Repurchase agreements up to 5% 20

21 Appendix 3 Target Strategic Asset Allocation, Minimum and Maximum Deviation Limits Instruments Minimum Target Asset Allocation Maximum Cash and equivalents 0.00% 4.10% 20.00% Deposits 2.00% 7.00% 25.00% Government bonds 15.00% 37.00% 60.00% Mortgage bonds 0.00% 0.40% 10.00% Corporate bonds 5.00% 15.80% 25.00% Municipal bonds 0.00% 0.20% 10.00% Infrastructure bonds 0.00% 0.00% 10.00% Equity 7.50% 16.20% 20.00% REITs and real estate 0.00% 3.60% 10.00% Collective investment schemes 7.50% 14.30% 15.00% 21