Hugh Wheelan finds doubts as to the impact on domestic equities

Opinions in Belgium are proving divided as to the best way forward for pension funds in terms of asset allocation and the forthcoming arrival of the euro.

On the one hand there are those viewing the new euro market as an opportunity to diversify investment away from what they perceive as an increasingly risky domestic market.

And on the other there are those who feel the risk to the Belgian market is being overplayed and that investment sense and national sentiment will stem any predicted flow of assets across the border into the euro 11.

The VKG/CPM Belgian pension scheme for doctors, dentists and pharmacists is one such fund accelerating its global strategic asset allocation plan, ahead of its planned five-year review next year , in preparation for the single currency.

The early review, to be finalised in December, is due to what Karel Stroobants, deputy general director of the fund describes as extremely fast market movement" in Belgium to be ready for the currency changeover.

However, the fund has been preparing its bond portfolio for some time now, to align it with the forthcoming euro market.

The fund's bond briefs, all in plain Belgian government debt were transferred into deutschemarks two years ago to ensure a safer transition to the eventual arrival of a euro-bond, Stroobants explains.

"At present it is up to our investment managers how they mix their currencies as long as they are in future Euroland countries, then finally we will make the move to solely euro denominated bonds next year. The only risk factor we have is the bond duration, and we are trying to narrow this progressively."

In terms of the fund's three equity portfolios, consisting of one purely Belgian equity brief, one Europe ex Belgium large cap and one mid and small cap Europe ex Belgium, these will shift to three pan European funds, withdrawing completely from the Belgian equity market.

According to Stroobants, the fund sees no reason to retain its present 18% "risk" in Belgian equities with the prospect of less exposure in a strong euro market, and he is certain similar moves by other funds will have a "huge impact" on the Belgian market.

"It has been a very difficult decision because our Belgian managers have regularly outperformed a good domestic market, sometimes by up to 500 basis points. However, we have to look solely at our liabilities which means avoiding any national sentiment or following peer groups and making this necessary move to euro equity denomination."

Stroobants cites increasing illiquidity in the Belgian market as the prime risk factor behind this exodus, with large Belgian companies being syphoned away from the country through mergers and acquisitions, and a lack of institutional or foreign money coming in to replace them.

The only uncertainty remaining for the VKG/CPM fund is the reallocation of its small cap portfolio, he says, with the mid and large cap portfolios already well positioned in a 'euro sense', but he feels this will probably take the form of a growth mid cap under the euro.

Many Belgian funds however are still in the process of deciding upon any asset allocation changes to be made before next year.

Alain Pireau, member of the board of directors of the pension fund at Caterpillar, the plant vehicle producers, says the company is currently implementing its new strategy to take advantage of the euro opportunity.

"We know the advantages of extending our asset allocation to the euro and lowering the risk of our investments. It is just a case of discussing it thoroughly with our asset managers before we move," he says.

However, Hervé Noel, head of the Belgian Pension Funds Association does not feel the shift away from Belgian equities will be quite so drastic.

"Certainly pension funds will reduce their present average exposure of 17/18% to Belgian equities in favour of the euro market. But despite experts saying they should not hold any domestic stocks for diversification reasons, I don't think anyone will be so bold as to totally abandon the Belgian market. A little national sentiment will play a part in this."

In terms of international equity diversification Noel says there is a split in Belgium between funds looking to follow efficiency models stating the need for no more than 20% of equities outside the Euroland, and those not wishing to ignore the rest of the world and retaining up to 50% in overseas markets.

The bond market shift however, he says, would be much clearer overall in Europe, citing strong agreement amongst pension fund managers that a euro market will be much less exposed than smaller country entities.

The trend for further bond exposure will stop at the Euroland border though, Noel says, due to the efficiency and low tax treatment that would be lost by looking towards the dollar or yen.

"The Belgian bond market has been diversifying for some time now though, so I don't expect any great change to follow the euro introduction," he adds.

The view is backed up by Paul De Smet, partner at Conac, Brussels based actuary and consultancy firm, part of Woodrow Milliman.

"The euro will definitely lead to less focus on investment purely in Belgian equities, but we see this happening gradually for pension funds, particularly as many are strongly influenced by unions looking to guard national interests in terms of investment and employment," he says.

Philip Neyt, general manager of the Belgacom pension fund, which has around $3bn in assets, also believes that despite the relative unanimity in the move from Belgian to euro bonds, the equity market by comparison will not undergo any dramatic change.

Neyt says the bond switch, which saw Belgacom drastically reduce its Belgian bond exposure from 50% to 8%, came about through a need for increased choice in maturities and greater possibility to add market value. This opportunity incurred no cost, andindeed in what was a smooth market transition, fund managers actually benefitted from yield pick-ups, he adds.

However, on the equity side he says that although the euro is prompting further foreign investment, this is not necessarily to the detriment of Belgian equities.

"At Belgacom we are increasing our international exposure, due to studies we have made on risk tolerance and diversity, but this will all be new money from the continuing transfer of the previous pay-as-you-go system to being fully funded, not reduction in Belgian stocks.

"If anything, I believe future equity shift will be from country to sector allocation on a global scale. As an example, just moving to a Euroland equity exposure would miss out on the large and extremely high performing personal health care market in the UK and Switzerland."

Furthermore, he says, if the fund changes its allocations now it will only have to repeat this should the UK join, with the only benefit going to traders.

Neyt concedes most Belgian companies will slightly reduce their domestic equity exposure, in part due to the market volatility created by the mergers of such companies as Generale Bank and the subsequent departure from the Bel 20 stock exchange, which has seen market capitalisation drop by 15%.

He believes though that active managers could profit from this high volatility, and that any quick shift to foreign equities would be equally as risky, with companies influencing their own quotes on the markets in question.

Regarding illiquidity in the market, Neyt believes the problem is not nearly as bad as suggested. He argues that new money has been feeding into the market primarily from individuals and unit trusts shifting heavily into equity investment following disappointing bond returns, although he admits there are some fears concerning their knowledge of the risks involved.

Overall, Neyt appears calm at the possible impact of the euro on Belgian pension fund asset allocation: "Certainly funds will continue to move to international equities seeking out the sectors to invest in which aren't present in the limited Belgian market.

And if anything the euro will act as a catalyst to this, helping to sell the idea of further diversity to board members of Belgian companies. But I don't think the euro is a goal or an obligation in itself to change our portfolio structures.""

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