Siemens feel they have reached the end of the line with the book reserve system. Herbert Lohneiss tells Fennell Betson why he is not satisfied.

At Siemens, they reckon they have gone as far as they can to funding the group’s enormous pensions provisions under the book reserve system. But Europe’s largest corporate employer does not think this is far enough.

As Siemen’s head of investment Herbert Lohniess puts it: “In Germany the only way currently we can to do it is to pile up cash on the asset side as we do at Siemens, which has been given the name of ‘asset funding’.”

In effect, this means building up funds internally and designating these for pension purposes. Siemens has put aside DM17bn ($10.5bn) in liquid assets to meet its domestic pensions liabilities under the book reserve system.

The group is not unique in accumulating cash in this way, but its thinking is illustrative of how major groups come to terms with the problems book reserving brings. When a company becomes aware that it is generating this liquidity, it wonders if this build up is surplus liquidity or does it serve a particular purpose. It is not very hard to figure out that its purpose is to fund the pension liabilities - and it’s probably a very good thing to do that.

But Lohneiss rejects the notion that book reserving is unfunded. “”By what we call unfunded liabilities we mean pension liabilities funded by one single share - that of the employer. And that does not have the highest degree of security attaching to it.””

He thinks it makes sense from from both the employees’ and employers’ viewpoints to have a funded scheme. “Firstly, it is an intelligent way of handling surplus cash. Secondly, it provides more flexibility in the long run.” Here he is thinking of the transfer of pension rights and so on.

But Lohneiss has no illusions as to the reality of what has been achieved by Siemens’ internal funding: “”This does not have a lot of legal effect behind it, it is more of a voluntary way of taking care of the situation. So far, there is not much more that we can do.”” This is not a feasible long-term solution in his view. “”There has to be a change in the law to enable you to take these liabilities and assets off the balance sheet. That is when you will really have a pension fund.

Some external funding is done through a long-established Siemens Unterstutzüngkasse and its DM2bn($1.2bn) in assets are also looked after by Lohniess and his team. Due to the different approach in accounting for liabilities, it is a financially “”unsurmountable”” to move from book reserves to using this as a vehicle currently.

So Siemens’ chosen path is to “try to get as close to running an external pension fund as we can”. But severe constraints shackle those trying to run a pensions portfolio within the confines of a corporate balance sheet, as Lohneiss has to do. The relatively high risk investment approach that the long-term nature of pensions liabilities allows has to be tempered by the fact that “”we are on the balance sheet of an industrial company””. Too great fluctuations on the pensions assets will impact on the earnings of the company. Also, many sponsoring companies within the group are risk averse. The end result is an investment policy where annual returns must not fluctuate unduly. “So we cannot strive for more than 7 or 8% annually in Deutschemark terms annually.”

“If we were an American pension fund with the type of tax treatment it has, we could go for a 9 to 10% return yearly - so we give up 1.5% based on organisational constraints. Over the long term that is a very high cost.”

As a result, German companies are losing out on some of the real investment market opportunities and this impacts on their cost structures. “Our international competition does not care about the problems Germany may have in this area.” Awareness of the problem is begining to grow, but has not yet reached a sufficiently high level. “You still find people saying that book reserves have no cost. They have no cost in interest terms. Accounting procedures do not give much guidance on how to evaluate the cost of book reserves, but clearly there is a very high cost.”

An additional sting in the tail for Siemens is that despite funding in full for its liabilities, it still has to pay premiums to the national pensions insolvency insurance scheme.

The structure Siemens uses to handle these assets is a series of nine spezialfonds, which are specialised portfolios run on mutual funds lines, with the investment services being provided through the Siemens Kag subsidiary, known as SKAG, run by Lohneiss and his team, investing a total of DM22bn ($13.5bn).

“We have 12 people handling securities, including myself.” Bonds comprise 75% of the portfolio and five managers trade these, one currency trader and two are on the share trading side. A third of the bonds are global and 40% of the DM4.9bn shares held are in domestic stocks.

They are certainly not wedded to handling everything in-house and five external managers are used for international shares. The ‘make or buy’ decision is carefully weighed up each time.”“But we do not want to give up our ability to handle shares.””

The asset allocation between bonds and shares is a factor of the organisational constraints, admits Lohneiss. “”We would not mind at all increasing our equity portfolio to 40% if we could take the volatility going with it.””

Strategic and tactical asset allocation are vital contributors to returns. “”We have strategic - half annual - updates on a monthly cycle following external discussion and this is executed daily.”” Asset allocation provides an overall framework and it means responsibility is distributed among all portfolio managers, each with their own benchmark returns.”” Only if we try to beat the benchmark on each individual fund will we able to attain the benchmark for the total DM22bn. It is a major success if we achieve this - and by and large we do.”” The return achieved for the financial year ended September 1996 was 11% in line with the internal benchmark.

Tactical asset allocation decisions are a major component of the success, he says. “”We make money from TAA, but it is hard to measure it.””

Lohneiss believes that fixed interest markets are becoming more uncertain, with the disappearance of the long-term cycles, with the result that portfolio managers have to become even more active and hard working to get their returns. On the equity side, he describes the approach as “”closer to top down””, particularly in relation to the domestic DAX. “”The stocks there have a high correlation making a top down approach reasonable.”” But in relation to the German ‘mid-cap’ stocks, you have to be ‘bottom-up’.

‘Market timing’ is an area where Lohneiss thinks there are real opportunities to be different to others. “But you have to be very disciplined, and one the ways to be disciplined is to use quantitive methods.”

Lohneiss is a firm believer that external funded pensions will come to Germany by the multi-nationals. “However, it does take for ever to change the situation because of the tax and legal environment - that is the major impediment for the development of funded pensions.”

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