GERMANY - The court of auditors in the German province of Rheinland-Pfalz (Rhineland-Palatine) has told the local government that the pension fund for civil servants should start diversifying and that management should be outsourced.

The €1.9bn fund, set up in 1996, had recently been criticised by academics who noted that an investment in local government debt did not constitute a funded system, but merely a PAYGO-system in disguise.

The province's court of auditors agreed with this evaluation and recommended that the government draw up an asset allocation for the fund.

In its report, the court said: "The fund's central aim to relieve future budgets is not reached as long as it invests in local government debt."

As per year-end 2009, around €980m of the fund's assets were invested in local government debt and another €800m in debt issued as zero-coupon bonds by a part-government owned company.

The court of auditors said: "From a return perspective, portfolios solely invested in government bonds bear the same risk over the long term as suitably structured mixed portfolios with a diversification over several asset classes."

The court cited an ALM-study for the German province of Hessen that showed the optimum asset allocation for the civil servants' fund would be 30-45% in equities and real estate and 50-75% in diversified government bonds in the euro-zone.

An ALM-study is also among the court's recommendations for Rheinland-Pfalz.

It was also pointed out that, among others, the provinces Baden-Württemberg, Bayern and Mecklenburg-Vorpommern, as well as the fund for federal civil servants, were already using equities in their portfolios.

The ministry had argued that, when setting up the fund, investing in local debt would "relieve" it from the task of making investment decisions. 

However, the court of auditors noted that any asset management should be outsourced to experts like the German federal bank, which is already managing some assets in similar funds in other provinces.

Another point of criticism mentioned by the court of auditors is the fact that, since 2006, the money paid into the civil servants fund is entered as a loan, which then enters the books as an investment to the fund, which, in turn, increases the province's potential for taking up additional loans.

According to the court of auditors, this current scenario will not help relieve future budgets, but it welcome in principal the creation of a fund for retirement provision, as it could potentially increase cost transparency.

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