A quiet day is what they wanted and a quiet day on the markets is what they got at the Bayerische Versorgungskammer (BVK) in Munich when transitioning part of the E30bn fund recently. “We got our timing right and the reports show that the operation was very successful,” says Daniel Just, chief investment officer of the fund.
This was a big day for Germany’s largest pension scheme in terms of assets, the culmination of many months of planning to introduce a new flexible structure for the 12 pension schemes the BVK looks after for a range of professions and other occupations that includes medical doctors, pharmacists, architects, engineers, chimney sweeps and orchestra members in Bavaria and elsewhere, who are required by law to pay contributions to the BVK.
“We mainly provide the first pillar pension arrangements and take in contributions that would otherwise go to the state system,” he explains. The BVK, which belongs to the Bavarian state, acts in a joint management capacity with the 12 schemes (See listing) managed. Three of the professions, the doctors, dentists and vets in Bavaria, have just single a arrangement making it the biggest with assets of E11bn. But in terms of contributors, the largest scheme is that for Bavarian civil servants with over 1m members.
Each of the 12 schemes are independent, with their own individual supervisory board, for example, the medical doctors pension scheme have representatives of the profession forming their board. “So each scheme is individually managed, but run by one management that of the BVK,” Just says. The whole organisation employs over 1,000. On the asset management side there are 160 staff, with 12 looking after equities and 16 fixed income, and the rest running the extensive real estate portfolio.
“The fund is still growing rapidly, with contributions running annually at E2.4bn and benefits payments of E1.8bn,” he says. In the time since he joined over six years ago from HypoVereins Bank, assets have doubled. “This fast growth rate is expected to continue in the future.”
Because the assets are funding first pillar commitments, the approach to asset management has to be very conservative, says Just. “We regard risk management as the most important aspect for us. The accountancy rules we operate by require our accounts to be in balance. We cannot be in deficit.” In fact, the fund has to achieve a guaranteed return of 4% per annum, which compared to life companies’ 2.75% guarantee, makes this is an ambitious level, he reckons.
The BVK has always had a comparatively small proportion invested in equities around 9% at fund level, but the current strategy is to increase this proportion to widen the diversification of the fund. The fixed income allocation comes out at around 85% and the real estate at 6%.
However, this asset mix does vary from scheme to scheme. “This was as a result of an asset liability study we did some time ago, which showed that the different schemes had different risk profiles,” he points out.
On the fixed income side, the strategy is very much ‘a 10-year buy and hold’, says André Heimrich, head of asset management at BVK. “With such an approach, it is only possible to diversify very slowly, otherwise you could end up destroying the system in a short time. But the bond portfolio is being reduced gradually and the assets released are used to diversify the portfolio.”
The main instrument used is Schuldscheine, which are bonds often issued directly to one investor such as BVK by state governments, private banks or Landesbanken, with an enhanced rate of return. These account for over 80% of the portfolio. As they do not have to be marked to market and maintain their book value throughout their term of 10 years, they are attractive to long term investors like BVK, with their enhanced yields.
“Such an asset is very helpful in calculating the future flows to the fund,” says Just. Since what the fund requires is to have a stable and known income position, and not one that fluctuates from year to year.
Heimrich adds: “In addition we have government bonds, perhaps 2% of the portfolio, and some structured bonds. In the past year, we have invested in corporate bonds and have invested in asset- backed securities.”
The real estate portfolio, where the allocation amounts to 6%, has undergone extensive change to move the focus from Bavaria and residential properties. “Currently, we have 12,000 residential properties, plus some 350,000 square metres in office space, but we have been diversifying, firstly by buying elsewhere in the main German cities and acquiring offices solely. We have implemented real estate portfolio management, as the old buy and hold strategy was changed to a more active approach to generate higher returns.” Now the residential element is down to 50% of the portfolio, from 85% a few years ago, points out Just. BVK also stepped outside Germany investing in pan-European situations. “Four years ago we set up our own Spezialfond with E500m, with 50% leverage, investing in France, Spain, the UK and the Czech Republic. The fund is setting up a new E500m Spezialfond in 2004 on a pan European basis with a 40% stake in the US.”
While Just is happy with the 6% level, he says it is possible that this will be increased slightly, but this will depend on market opportunities. “It really varies with the kind of projects that become available.”
While the equity department has a small 2% portion that is directly held, most of the holdings are through Spezialfonds. “We believe that equities should be managed externally, as we do not have the resources to do this satisfactorily in-house,” says Heimrich, who adds that the directly held proportion that is likely to shrink further.
Before the recent portfolio restructuring and transition on the equity side, BVK’s range of equity funds was measured, often with the same benchmark. “So we found we were paying a series of active management fees for passive performance, which was not very efficient,” says Just, who reckons that in all the fund had 24 Spezialfonds, a number that was set to grow even further if nothing was done about it.
But it was not just the numbers that made the system unwieldy, he points out. Every KAG, custodian and asset manager was different and had their own reporting and accounting systems. “The fees may have been low, but they were dirty fees and you never knew exactly what you paid for what. There was no integrated reporting and many contacts to maintain. To change your asset manager meant going through time consuming and complicated procedures.” He sums it up: “It was all a bit too complicated.”
While the idea of changing the structure of the equity portfolio had been in the air for some time, the question was very much one of getting the timing right. “One issue was that of the hidden reserves in the Spezialfonds. These have to be disclosed once the funds are being closed,” says Just. So it was a matter of obtaining agreement across all the 12 pension schemes to arrive at a consensus.
“We were very conscious of our reliance on just two asset classes, fixed income and European equities and that we just had to diversify it more than in the past,” says Heimrich.
“We knew we needed integrated reporting as our first step, in order to have better risk management and budgeting,” says Just. That meant a global custodian. “But we came to the conclusion that we do not need lots of KAGs, but a master KAG.” So the BVK at the beginning of last year took its first step to find the custodian and master KAG provider, by holding its own beauty parade. “We chose BNP Paribas as our custodian and Universal to run the master KAG structure.”
The fund took this initial step without external consultants as it felt that the number of serious players to be considered were relatively few. “There were just not that many players in either field,” says Heimrich. “We put together our own questionnaire for three custodians and four master KAG providers.”
“First we selected the global custodian, as we reckoned this to be our most important partner, since they handle the performance and risk measurements. BNP Paribas was chosen because we felt their reporting system was the most flexible and that they were very committed to the business long term. We obtained assurances about that aspect from them, as we see a global custodian as a long term partner.” The performance measurement system provided was very convincing, he adds.
The choice for master KAG came down to two. “We visited these along with the global custodian as the interface between the bank and the master KAG is very important,” says Heimrich. “Here we reckoned Universal would be best for us, particularly with their experience in this business, which is the most extensive in Germany.” BVK found this to be crucial when it came to appointing the asset managers, particularly those from the US, as they had many requirements in their contracts. “Universal did a good job there for us.”
The question of finding the right structure for the master funds was the next stage. “What we want is one production platform for all our pension schemes, so that by asset allocation they can take stakes in the different master funds,” explains Just. This will enable them to choose which of the funds they want and the proportions. “It gives them freedom over the allocation and risk levels in their funds, which are the most important decisions to be made. And it enables them to do this efficiently.”
The aim is to build master funds where within the funds the correlations of the different segments are as high as possible, but where the funds have low correlations with each other in order to provide diversification. So the initial range of five master funds comprise equity Euroland equities large cap (with five managers), equities world large cap (one manager), equities small and mid cap (four managers) and corporate bonds/spreads (five managers) and a Euroland balanced master fund (five managers).
“There can also be style diversification within the master funds,” Heimich points out. “So in some funds, there could be relatively high proportion of passive management, in one fund this comes to nearly 50%, 25% is quantitatively based, and the other quarter is fundamental and active.”
Heimrich says that in the global master fund the US is just the first step; later this can be expanded to include other areas such as Asia-Pacific. The balanced fund is taking an innovative approach by investing in both equities and bonds, including convertible bonds, and using tactical asset allocation techniques, in what Just calls an “asymmetric way”. It can provide capital protection facilities with both absolute and relative return strategies.
“The structure is very sensible is that you can add classes within the master fund to reduce risk or enhance expected returns, or just to add a new master fund. But we have laid down a number of guiding rules, so for example, any additional inclusions at master fund or master KAG level must have a positive effect on the whole portfolio. We want to make sure we do not end up with chaos.”
Also, the aim is to make sure there are the same rights for the smaller schemes as the bigger ones. “So our rules to change or find asset managers are laid down in detail,” says Just. The process the fund has now is very transparent. “For this round we did use consultants, Alpha Portfolio Advisors, who managed the manager selection beauty contest for us. The process was strict and fair, in other words existing and new managers were starting on a level playing field.”
The appointing of the 17 managers that are now in place was something of a marathon. Those managers on the long list, including existing managers, were sent a detailed questionnaire running to 30 pages plus, and the responses were analysed before drawing the short list which ran from three to five managers depending on the asset class. “Then we asked them to present on the special day selected for each asset class,” says Heimrich. On the basis of that, the BVK’s board of management confirmed that it was happy with the selection process.
“This gives us a process that enables us to make changes and choose new managers perhaps for the next decade,” says Just. “It gives us a structure for the future.”
Then the next stage was to move to arrange for the transition management. “We knew that this was an area where we could lose money if it was not done properly. Here again we held a beauty competition, with Deutsche Bank winning the business.”
The E2.5bn transition all happened on one day, without any tremors in the marketplace to indicate what was going on.
The next major task is to do another asset liability study for each scheme to see what the goals of each one should be and to arrive at a model portfolio for each. The fund is also looking at other areas as possibilities for the future, says Heimrich. “One potential area is an alternative master fund. We have been looking at hedge funds, at high yield bonds, emerging markets. Our approach is one of trying to ascertain which strategies – particularly on the hedge fund side – make sense in the whole context of the portfolio. So it may be that only market neutral are of interest, as we have exposure to the other risks within the other funds.” With the change in the German law allowing hedge funds the timing could turn out to be propitious.
Overall, the BVK came through the period in much better shape than many in the financial sector, says Just, pointing to the problems that have hit many insurance companies. “We still have some 10% of assets in hidden reserves. This enables us to take on more risk in other classes.”
In the good years, BVK has had returns of 7.5% annually, though this came down in recent years, it has averaged over 5.6% in the past six years. In 2001 and 2002, it took the decision to write off any losses in full and not to use the leeway the authorities gave to do this only partially. This meant that returns were hit in 2002 to around 2.4% net. “But this year, we are expecting the figure to be 6.5%,” says Just, “well above the 4% minimum requirement.”
He adds: “We feel that we have a very good structure in place, with a menu of choices so that the different pension schemes can come to the table and be sure of the quality of what is available for them.”

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