FRANCE - France's Fonds de reserve pour les retraites (FRR) has unveiled a completely new liability-driven investment (LDI) strategy to meet its obligation to pay €2.1bn each year to the Caisse d'Amortissement de la Dette Sociale (CADES) until 2024, when the fund will close down for good.

The shake-up will see the fund use more alternative indexation and take on much more emerging market risk in its performance portfolio - changes that will result in several opportunities for asset managers over the coming months.

A call for tenders for liability-matching French Treasury bonds and for passive management of investment-grade international sovereign bonds - both intended for the new strategy's 'hedging' portfolio - has already closed, as has a call for the fund's tactical asset allocation overlay mandate.

Calls for tenders for market-cap and also non-market cap weighted passive developed market equities were put out at the end of January.

Philippe Aurain, who has led development of the new strategy since he took over as CIO from Nicolas Sobczak in April 2010, told IPE: "Because our new portfolio is far removed from our old portfolio, this will necessarily lead to calls for tenders over the coming months.

"We will also look again at the way we use mutual funds. We will use them a lot more in emerging markets and high yield, for example, where it is more difficult to create mandates in these universes, and in the transitional period before launching calls for tenders for mandates later this year."

FRR's liabilities changed significantly in December 2010, when parliament passed legislation that will see €2.1bn per year transferred from the fund to CADES, which refinances the debt incurred to pay pensions in the social security system, as part of the government's broader reforms of France's pay-as-you-go (PAYG) pension.

There will be 14 payments made between 2011 and 2024.

Before the reforms, FRR was intended to make up part of the shortfall in the PAYG system caused by demographic ageing, starting in 2020 and lasting until 2040.

In addition, whereas FRR has hitherto received inflows from the 2% social tax, surplus funds from the Caisse Nationale d'Assurance Vieillesse (CNAV) and Fonds de Solidarité Vieillesse (FSV) and proceeds from privatisations, from 2011, it will no longer receive these inflows.

To secure those new liabilities to CADES, FRR will now maintain a 'hedging' portfolio of bonds, initially hedging 85% of the cash flows, but potentially increasing in the future via an opportunistic de-risking programme. That portfolio currently takes up around 60% of FRR's assets.

The remaining 40% will make up a 'performance portfolio' with a target return of 6% annualised, split 70% equities and high-yield bonds, 15% emerging market debt and 15% real assets (listed real estate and passive commodities excluding agriculturals and softs).

The strategic positioning of the equity portfolio will be split one-third each into European, other developed market and emerging market stocks.

"That allocation will be subject to a lot of flexibility," said Aurain, "but in any case it is very far away from the usual benchmarks, particularly in terms of exposure to emerging markets, and a long way from what we used to have."

FRR made commitments to private equity funds managed by Pantheon Ventures, Access Capital Partners, Neuberger Investment Management and Axa Private Equity Europe in 2006-07.

The shorter time horizon of the fund's liabilities means these are no longer considered suitable. Distributions will be re-allocated to the listed equity portfolio, and no new private equity commitments will be made.

There are no plans to include hedge funds in the performance portfolio at this stage.

With assets worth around €37bn, FRR is currently 140% funded. If the performance portfolio achieves its expected returns, there could be a lump sum of as much as €18bn left in 2024.

Any remaining assets will be transferred as a one-off payment into CADES, at which point FRR will cease to exist.

Aurain offers more detail on FRR's new strategy in an excusive interview in the May 2011 issue of IPE.

"In a way, you could say that now we are talking about FRR 2.0 - it's a totally different fund, we are starting from scratch," said Aurain.

"But it wasn't a big shock to us to face this new framework, and in a way it helps to have a precise liability, a precise time horizon and a precise objective - to deliver those liabilities safely to CADES."

 

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