Steady as she goes

How have European pension funds adjusted to the new economic climate, where equity markets are more volatile and where real rates of return have fallen and look unlikely to recover in the short to medium term?
In a low yield environment with high volatility, one might expect a substantial shift in investment strategy, with pension funds retreating from equities into asset classes that offer either better returns or greater security – or both.
However, the broader investment horizons of pension funds have meant that pension funds can afford to take a longer view than other institutional investors do. The message from many leading funds, in terms of their investment strategy, is “steady as she goes”.
Certainly Europe’s largest pension funds have held their course like supertankers. The e150bn Dutch civil servants’ pension fund ABP says it is sticking to the investment strategy it devised as a result of its asset liability management (ALM) study in 1999; a strategy of moving progressively from bonds into equities.
Michel Meijs, spokesman for ABP, says there is no intention to alter course: “The current investment climate has no influence on our asset allocation. We will continue our strategy of increasing equity exposure and that of alternative investments and a decrease of fixed income,” he says.
Scandinavian pension funds have been able to make any tactical adjustments within prescribed strategic limits. Eddie Dahlberg, managing director of the Göteborg-based SKr7.2bn (e770m) Volvo pension fund, says that there are no plans to make any changes to the fund’s allocations. “The fund has limits on maximum and minimum allocations to the different classes and the current climate has influenced how assets have been allocated,” he says. “These limits have not been changed either.”
Belgian funds, too, have made tactical rather than strategic adjustments. Hervé Nöel, director of the e1.54bn Tractebel pension fund in Brussels, says he has fine-tuned rather than overhauled the portfolio. “The current investment climate has not led to any change in our strategic asset allocation,” he says. “From a tactical point of view we have reduced somewhat our exposure to equities – from 53% to 50%.”
However, he emphasises that this was a measured rather than knee-jerk response to market conditions. “What this actually means is that we rebalanced cautiously and gradually from bonds to equities,” he says.
Nöel is also sceptical about the current unpopularity of equities vis-à-vis bonds. “This probably says much more about the volatility of investors’ moods than anything else. The job of ‘tactical allocator’ – something we can all do excellently with the benefit of hindsight – is certainly the job of the future.
“For ourselves, we do not think that the new millenium immediately invalidates the theory of long-term superiority of equities as investment vehicles,” he says.
He also has mixed feelings about moving into alternative investments. “Hedge funds are attractive in principle because of their fairly stable return and diversifying effect, but they suffer from poor benchmarking and high fees,” he points out. “Convertible and high yield bonds can be an interesting bridge between equities and traditional high quality bonds.”
The Tractebel fund plans to carry out an ALM study next year, he adds. “My best guess would be that we will not change assumptions about returns, but that the expected volatility of equities will be substantially higher.”
Pension fund strategy is always likely to be determined by long-term economic and social trends rather than short-term movements of the market, says Philip Neyt, director general of the e3.5bn Belgacom pension fund in Brussels.
“Our strategic allocation is determined by our liability profile and the risk tolerance that the plan sponsor is prepared to take,” he says. “In the ALM we look for long-term trends and we are trying to let assets and liabilities move in tandem . We ignore short-term market movements.”
However, Neyt says he does carry out stress-testing, using different economic scenarios. He says the fund has responded to low yields and high volatility in three ways:
q First, it has diversified among and within asset classes.
q Second, it has looked for better yields to achieve an acceptable return – but without jeopardising the profit and loss of the plan sponsor. Neyt says he is looking at possible holdings of corporate bonds. This is a market that he believes will develop further, especially in Europe where, he says, debt financing is becoming a cheap source of company financing.
q Third, it has created a more efficient manager structure. “We moved from balanced to multi-asset and now to really specialised mandates,” says Neyt. “We will simplify our structure with special attention to less correlation in our portfolio of mandates and managers. We will do that in full transparency with our managers and we will clear briefs going forward.”
European pension funds have typically responded to the deteriorating investment climate by tweaking their portfolios rather than making wholesale changes. The changes in asset allocation at the SFr1.3bn (e879m) Beamtenversicherungskasse des Kantons Zürich (BVK), the civil service pension fund in the Zurich canton, illustrate this process (see table).
BVK’s performance between January and October this year was the worst for the past 25 years, says Daniel Gloor, head of asset management. The fund achieved a return of – 9.9 % against a benchmark return of –9.1 %. Total assets fell from around SFr19bn at the beginning of the year to SFr17bn at the end of October.
Fluctuation reserves, which stood at 18% of total assets (that is, with a coverage ratio of 118%) at the beginning of this year declined dramatically to around 3% by the end of October.
However, Gloor points out, the fund is still fully financed and liabilities are still 100% covered by assets. As a result, BVK’s investment committee decided in October that no changes should be made to the current strategic asset allocation.
The fund made various tactical changes, Gloor says, in response to the market conditions. “During the course of the year, we have not yet considerably reduced the quota within the foreign-denominated straight bonds and we always kept a high degree in short-term investments. New funds of some SFr100m flew into convertible bonds.”
BVK has put no further money into Swiss equities, he says. Exposure to foreign equities was already small, with SFr100m invested in indexed MSCI investments and SFr100m invested in small and mid cap US equities. However, the fund has stopped investing in emerging market equities, and has liquidated its entire investment of SFr200m.
Investments in domestic real estate have increased marginally (1.4%) by SFr300m, and Gloor has taken a cautious line over alternative investments. He has increased the quota of private equity holdings slightly, from 0.5% to 1.2% of total assets. However, he says that no new alternative investments – apart from private equity – have been or will be added.
Looking into next year, Gloor says that no substantial changes will be made to the asset allocation of the fund, other than an increase in foreign equity holdings of around 3% and a reduction in foreign bond investments of the same amount.
“We will stick to high-quality investments and within the equity portfolios, around 75% will be managed on a passive, indexed basis in the future too,” he says.
So it appears that most pension funds are prepared to weather market instability rather than run for shelter. In the long run, they believe this is the only sensible course.