The European Patent Organisation (EPO) is a supranational organisation granting patents for the 15 EU countries as well as Cyprus, Liechtenstein, Monaco, Switzerland and Turkey. Its more than 5,000 employees are based in Germany, the Netherlands and Austria, with the overall mix of its staff broadly reflecting the population weights of its member countries.
Since they are not subject to the national social security systems of these countries, the EPO decided to set up its own pension system. While the scheme was initially run via the budgetary system, a pension reserve fund in its embryonic form was established in 1983, with the purpose of lending support to the pension scheme by providing the appropriate reserves, and making the EPO one of only a handful of supranational organisations to build up sufficient reserves for future benefit payments to its employees.
Plan assets for the Pension Reserve Fund (PRF) currently amount to E1.8bn, 65% of which is invested in equities (35% Euro-zone, 30% foreign developed markets, 5% emerging markets) with the remainder in bonds and cash instruments. This allocation is justified by the long-term nature of the fund. A significant aspect of the fund is that with such a variety of nationalities among its members who are likely to retire to their home countries, the PRF became among the first pension funds in Europe to invest on a pan-Euro-zone basis.
Investment operations are carried out by an internal team of three portfolio managers, headed by the fund administrator, Silvio Vecchi. All the fund activity is carried on by a team of 11 members, including back-office and book-keeping staff. To ensure a correct representation of results, all performance calculations are carried out by a specialised third party, the WM Company. The fund administration team and WM have developed a comprehensive new template for the performance report, which includes a thorough peer-group comparison, a quarterly performance attribution report, and several measures such as the alpha and the information ratio. As of the end of 2000, the fund had achieved a performance over five years of 15% against a benchmark return of 14.1% and outstripping its long-term actuarial objective by 9.9%.
During 2000 the fund outperformed its benchmark by 3.1% while the fund’s own information ratio was a top-decile 1.67 with alpha of 0.88. To further improve risk control, the administration of the fund has commissioned an external consultant to conduct a comprehensive review of its risk management approach, including a thorough examination of administrative, operational and market risks.
The fund also has its own compliance officer, who, acting according to an internally established code of compliance, ensures that the investment activity complies in content and form with all regulations applying to it. The pension fund of the EPO, being a supranational organisation, is not subject to national or European laws and regulations. To this effect it has developed its own set of guidelines and an internal code of procedure for carrying out investment operations, and rules for settling and bookkeeping procedures. A self-regulating code of conduct for the avoidance of conflicts of interest between the fund and its staff is also in place.
In terms of current asset management, the PRF is managed by an in-house team. In a study by an external consultant in 2000, the team compared well with other managers in terms of cost. For the fixed-income there are no restrictions on bond maturities and no such intentions regarding the fund’s long-term obligations.
The defined broad investment universe comprises high-grade bonds, which the fund assumes to have a low correlation with the equity exposure that dominates the fund’s allocation. The core portfolio of the bond fund is invested in European asset-backed securities and mortgage-backed securities, with government bonds, and sometimes derivatives, used to manage the yield curve and duration. Credit research and broker contacts are utilised to identify relative value and high probabilities of out-performance.
Performance attribution is achieved by small currency bets in relation to the foreign bond asset class and by duration bets against the customised benchmark. Inflation-linked bonds are also used for investments on a strategic and tactical level. The equity portion of the fund is based on a ‘performance-enhancing’ core/satellite investment approach. Investment funds are used where external in-depth knowledge is needed, such as allocations to European small caps and the majority of exposure outside the continent. Style, size and sector tilts are implemented by using funds appropriate to the investment outlook.
Market knowledge gained from direct investments is used to aid in the evaluation of mutual funds, while information from the latter often serves as a contrarian indicator that is exploited in direct investments, thereby creating a system of cross-fertilisation between the two.
In addition the PRF is negotiating new operations to be carried on for further enhancing its returns (securities lending) and exploring the possibility of implementing a currency overlay programme in cooperation with a leading institution in this field.

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