VBV Pensionskasse was founded following the merger of VPK Pensionskasse and BVP Pensionskassen in 2004. But even before the merger took place both pension funds had already realised the need to diversify within their fixed income assets, partly as a consequence of the low interest rate environment. After the merger, completed in late 2004, VBV’s asset management and risk management teams concentrated on the scheme’s asset allocation. They strengthened the scheme’s diversification among styles in the core fixed income asset class (made up of euro-denominated government bonds and collateralised bonds). Within this top-weighted sub-asset class, VBV allocated the active fundamental, trend-following/quantitative and index tracking styles.
VBV put clearly defined restrictions concerning maximum tracking error and maximum over and under weightings versus modified duration into place for each of the managers. The maximum exposure for out of benchmark investments was also clearly defined. Monthly standardised reporting and regular reviews conducted by the VBV risk management team ensure compliance with these restrictions.
All of the active asset managers are measured against the same broad customised benchmark: the Citigroup SB EUR BIG ex Corporates. This benchmark leaves a sufficient degree of flexibility for alpha generation activities versus the index. For index tracking funds that apply the stratified sampling method, there is a pure, more concentrated government benchmark: the JPM EMU. Investment-grade corporates represent another core asset class in VBV’s multi-manager/multi style concept. In this sub-asset class, the pension scheme allocates active fundamental, research-driven and quantitative styles.
The main risk the scheme faces in these core asset classes is interest rate risk. For that reason VBV started to diversify with an in-house managed absolute return bond fund in 2002. This fund’s goal is to achieve a steady positive return with low volatility. Since its launch in January 2002 the performance of this fund has been +6.63% per annum with volatility of 1.48%.
The asset allocation of VBV’s fixed-income portfolio includes sub-asset classes (or satellites) such as US high- yield bonds, global inflation linked bonds, global emerging market bonds, preferred securities, global convertible bonds, loans and hold-to-maturity bonds (top-rated bonds that reduce total volatility by being valued at book costs) as well as short-term fixed income investments and money market funds.

How these sub-asset classes are allocated depends on the risk profile of the portfolio, which is determined by the liability structure and thus by the demographic status of beneficiaries and prospective beneficiaries in the portfolio. For all of these sub-asset classes VBV has hired active managers that are capable of generating significant alpha over a long-term period. All mandates are reviewed internally on an annual basis. Being a euro investor and pension fund that has to pay its liabilities in euros makes it necessary for almost all foreign currency exposure in the bond segment to be hedged in euros.

Highlights and achievements
After using this core/satellite allocation for roughly two years, VBV has achieved strategic fixed-income asset allocation (defined by asset liability modelling), broad diversification of sub-asset classes, manager and style diversification, reduction of volatility, optimisation of the risk return profile along or close to the efficient frontier as well as higher returns in comparison with a pure euro government portfolio.

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