Tempered optimism across Europe

IPE asked six pension organisations across Europe: ‘How have you been affected by the recent market turmoil?' Interviews conducted by Nina Röhrbein/Liam Kennedy/George Coats

Valentin Fernandez, strategy director and responsible for institutional investor relations at Fonditel in Spain, the pension fund of Telefonica de España, which has invested assets of €4.9bn

The Spanish pension sector is suffering because of the market volatility. It has been a very difficult year and, while one may assume that risk control systems have not functioned very well, there was no model available to work with the levels of volatility we have seen.

So this is a year when there will be a strong variation in terms of performance. In our pension funds it depends on the risk plan. Our most conservative plan, the Telefonica pension fund, probably has an outturn of around -6-7% for the year to date, the medium risk plans around -12% and the most aggressive, Redactiva, it will be more than -20% because the market has declined something like 40% in the year to date. The numbers are horrible and that makes it tough for us to manage with them, at least for now. And it is also clear that, even if we do not have a recession, we have a very bad year ahead of us in macro economic and micro economic terms.

The negative performance is having a big impact on pension funds, eroding the confidence in these saving products, especially among those close to retirement age who will not have enough time to make up the losses and those who took early retirement.

The consequences in terms of asset allocation are translating into a lower exposure to equities and risky assets in general. Currently, we are gradually reducing our exposure to equity risk, which, unfortunately, has been very large in recent months. But now is not the time to sell, so we are considering reducing the less liquid positions a little, for example, external hedge funds that are not providing the targets of non-correlation with indices and preservation of capital that they promised and are not giving the expected return. However, in some cases it is not very easy to withdraw immediately.

There has been a proliferation of the hedge funds in recent years, which was a period when volatility was extremely low, and equities and fixed income were rising. As a result, in such a benign market, it was all too easy for hedge fund managers to operate. But now, in the new environment of uncertainty and tighter budgets, most are not managing very well.

In addition, the increased market volatility is forcing us to increase our cash position, not only as a cautionary measure - after all cash is king in turbulent times, as they say - but also because we should be prepared for potentially larger than usual withdrawals by the trustees of the pension funds we manage, aimed perhaps at transferring to other, more secured pension products.

But while it is logical to take refuge in cash in these tough times, it is a very easy way to lose future capacity because of the erosion effect of inflation. However, much of the money that has taken refuge in very liquid assets or in cash is on six or 12-month deposits so will not come back to equities or other risky asset markets in the short term.

Michael Atzwanger is managing director of PensPlan, a defined contribution territorial pension plan in northern Italy that has invested assets of €1.6bn

The current crisis has not affected us that much, in my opinion. Italy is not a financially sophisticated country, so banks and pension funds have not generally invested in complex instruments, therefore limiting almost completely direct sub-prime crisis related losses.

However, there are two effects that are inevitable. European markets generally are more exposed to securities related to finance and of course such exposure is negatively influencing the performance of our funds. So we are involved and affected by the downturn, but not so far by issues surrounding Lehman Brothers or AIG, for example. At the moment we feel quite comfortable.

Second, those pension funds that offer members different investment lines, distinguished by the range of equity exposures, are experiencing losses in the lines mostly exposed to equity, but this is something that has the potential to recover heavily over the coming weeks and months, even if volatility is a major feature of these portfolios at the moment.

Some of our members with concerns have been in contact but I believe most people realise they have lost more money in their general investments than in their investments with PensPlan pension funds. In addition, we are in close contact with various consumer protection organisations and if needed we would communicate directly with our members.

At the moment there is no need to initiate such contact, however.

The situation suggests more that our members would benefit from the introduction of lifestyle funds so we have in mind to develop this concept so members may have fewer concerns regarding their second pillar pension funds performances in the short run.

A year ago, we approached Cordares, which is now partly owned by the Dutch pension asset manager APG. And APG, through Cordares, will soon manage €100m of our overall assets within a Dutch FGR pooling vehicle, which we are developing together.

Since PensPlan is a territorial pension fund for the region of Trentino/Alto Adige, and is running old and new schemes, as well as managing assets from institutional investors, this pooling vehicle will initially be used for the management of old pension scheme and institutional investor assets. A further step will be the development of a pooling vehicle for Italian new pension schemes, as well as the development of a Dutch IORP vehicle for servicing Italian clients.

What we achieve initially through this letter of intent is European best practice in risk management and asset management. In a second stage, further co-operation, such as annuities, will be addressed.

We went with our trade unions to Amsterdam to go into detail about our agreement. The advantage of Dutch pension funds is that they have had years and years to gain experience in asset management as well as in developing pension solutions that really fit with the needs for their members. So we are trying to stimulate our social partners to start thinking what the real needs of our population are, in pension terms.

It is right for us to entrust our money to another pension fund. This is the essence of our co-operation. I see already at a European level that there is a trend for pension funds to get closer to each other. All pension funds should start to consider strategic alliances with other pension funds. There is not only an on-going process of globalisation in the insurance and asset management industry, but in the pension fund industry as well. Cooperation can mitigate negative aspects of such a globalisation.

APG considers us not just as a client but as a partner and we are trying together to set standards for a European co-operation model for pension funds. Our ‘territorial' PensPlan approach can be of great importance to set such standards, since pension funds still have to be somehow ‘local' regarding the relationship with their members - language, local offices, local communication strategies and so on. What has to be pooled together and become more efficient is asset and risk management as well as the overall operations of pension funds. This is the direction in which the co-operation with APG will lead us.

Fabio Filipozzi, CEO of Hansa Investeerimisfondid AS in Estonia, which has assets of EEK7bn (€450m)

Our second pillar funds were only created in 2002 and as a result we have no outflows, only inflows. So one could say that, in terms of flows, the economic and market downturn has not had an impact. But of course, in terms of performance, we have been affected quite heavily, which is common to all pension funds in Estonia.

Our K3 pension fund, which is the largest and has a 50:50 allocation to equity and fixed income, has a year-to-end-September return of -12.5%. The performance of our K1 fund, which is 100% fixed income, has given us a surprise in this market downturn. In previous years fixed income was a good protection during a downturn in equity, even a temporary one. But in this case it has been punished as much as equities because emerging market and investment-grade credit has also been heavily affected. And so K1 has a year-to-date near to 0, in that it was +0.5% at the end of September but -4.9% at 15 October. The third, K2, which has 25% in equities, has a year-to-date outturn between the other two, so -6.8% at end-September.

In equities 100% is invested abroad. In fixed income we have some local bonds but they are completely illiquid. In K3 these account for around 10% of the allocation, but given that it is a completely illiquid market, nothing has happened for the moment in price terms so we will see later if there will be any default.

And we have been affected by the general market environment. There have been rumours around Swedish banks and there is a general sentiment that confidence is weaker than it was three or six months ago.

We review our strategic asset allocation every year. Usually it does not change very much, but sometimes we will consider a new asset class or changing weight of an existing one.

However, now we are in the process of changing it for next year. From the tactical point of view, we had already repositioned K3 before the summer, reducing the active equity element to around 30-35%, well below the 50% benchmark. And in the last months we have not touched this allocation.

But for next year we are considering reducing the more risky elements of our fixed income part - so emerging market and high-yield - although the benchmark for equity exposure will stay more or less the same at 50%. And probably we will change our view on Russia. Until now we have considered Russia as a separate asset class, with a benchmark weighting in the equity portion of 7-10%. But we are thinking of merging it with emerging market equity into a single asset class, and this will probably reduce the Russia weighting slightly.

Instead we will buy some less-risky assets. In fixed income this will basically be sovereign bonds, while in equities we will move more into US, Europe - to older, more developed market equities.

Alternatives have been the innovation of this year. We added some eastern European private equity at the beginning of the year and it is one of the year's good stories, giving a return of around 10%. So we want to continue with it.

Patrick Groenendijk, CIO at Pensionenfonds Vervoer in the Netherlands, which has assets of €6.5bn

Although media attention has focussed on defaulting banks and other financial institutions getting into trouble, that has had a very limited impact on our pension fund.

This is because our business with such financial institutions is protected by very sound legal agreements so that, in the case of default, we have been able to easily terminate certain transactions and move them elsewhere without losing our investments. This was made possible because all our contracts with investment banks and asset managers are written under UK law. So an important lesson from this crisis is that good legal advice is crucial.

The factor that has had the most impact on us has been the movement of interest rates and equity markets. In particular, falling interest rates have been bad, although we have hedged 50% of our interest rate risk and consequently the impact is only half what it could have been.

But the severe fall in equity prices has also been very negative, although we think that at current low levels equities have become attractive to long-term investors. So we have already bought some, albeit in limited amounts, because we want to keep a very tight control of the risk in our portfolio. We find certain regions, such as Japan and continental Europe, very attractive, unlike the heavily indebted countries like the US and UK where the crisis will be more severe.

We are currently working on our investment plan for next year, which has a medium-term horizon of three-to-five years into the future. We are watching the credit markets for investment opportunities and as in the last couple of years we are looking for investments that are uncorrelated to recent events. In the long term not much has changed for us.

Another lesson we have learnt from this crisis is that diversification still pays off because some asset classes, such as US government bonds, have so far had a tremendous year, resulting in returns of more than 8% in the first three quarters.

In a couple of years' time we will look back on this period as a very healthy crisis because there were far too many banks and bankers. But it is nonsense to blame the short sellers for the market downturn. Of course, we have had to cope with the new regulation that put a stop to short selling, and of course we immediately abandoned the short selling of financial stocks. But we still take part in securities lending - excluding financial stocks.

To prevent the development of another crisis like this, UK and US consumers would need to save more and take on less debt. And that lesson is starting to trickle down now.

On the regulatory side, people always learn from crises and try to improve regulations. It will be very interesting to see what happens on this front because new regulations must not be counterproductive. But such crises are part of life and we will never be able to totally avoid them.

Wouter Pelser is CIO of Mn Services, the fiduciary manager owned by the DB PMT and PME metal industry pension funds in the Netherlands. It manages assets of approximately €59bn

We have a strong emphasis on operational risk management. We have reduced our securities lending level and there has been no securities lending on financials since about 19 September. We have also reduced our exposure to counterparties whose credit worthiness has deteriorated.

With collateral our programme was very strong. This means that, where we work with it, we ensured we had a programme for sufficient collateral, to 100% and more, and only in cash or in cash and sovereigns in the case of securities lending. There are a number of sources of information - rating agencies, our own analysis and the CDS market, which also gives us information about the market consensus on credit worthiness.

In terms of our exposure to counterparties we are contemplating a strong focus on agreements. We have already put the right procedures in place and that is one of the things we are very happy about. We work on daily collateral anyway but we have a very close eye on it today. Procedures have worked and we have lost nothing - neither money, commitment, agreement nor intention.

But we are obviously thinking about counterparty risk and that is the intensive side now. This involves all kinds of derivatives and securities lending that need collateral and we are working with that and with CSA, which is important in this field.

This also concerns interest rate and inflation swaps, commodities swaps and all other kinds. They are deployed in the portfolios and to a much greater extent in the overlay programmes. In foreign exchange you work with futures, so all collateralised programmes are affected - to sum up, we are working more and more with derivatives and collateralised programmes.

For tactical allocation we work with external GTAA managers and they are working on their portfolios. Also this year also we expanded a little in bank loans and credits. The climate is still turbulent in the financial sector but we have entered at good price levels and believe the pricing of credits and bank loans especially is such that it compensates much more than just the expected default rate.

The overall allocations are not that high but on a strategic level our clients are expanding credit and maybe they will do this next year as well. That was one of the investment plans for 2008 - we have done it gradually and we can continue to do it.

Further, we have made a programme for bank loans for clients and that is client specific, amounting to 1-4% of assets. What we did was make an agreement with Goldman Sachs to buy one portfolio of bank loans, which was a special case for one client. We are also working together from this year with a specialised asset manager for bank loans.

Christoph Ryter, pension fund manager at Rio Tinto Alcan in Switzerland and responsible for three pension schemes with a total assets of CHF1.45bn (€950m), the largest of which has assets of CHF1.3bn

Of course the market turmoil has had a negative impact on our pension fund. Although we have had positive returns on a year-to-date basis on nominal value assets and our Swiss real estate allocation, which makes up 20% of our portfolio and has so far been protected from the burst bubble effect of other real estate markets, they were overshadowed by the bad performance of equities and international real estate investment trusts (REITs), in which we have around 35% and 5% of our portfolio invested respectively.

Our exposure to hedge funds of funds - 5% - and commodities - 3% - also showed a negative performance. 

However, a recently undertaken asset liability study has confirmed our current strategy. Independent of the market turmoil, we intend to hedge the foreign currency risk more but we will stick to our long-term strategy.

At the same time, we expect the crisis to have long-term consequences on the fund because our funding level has dropped to below 100% and it will take a considerable time to regain a financial balance. In addition, Swiss pension funds need reserves to obtain a full risk capacity so effectively we need to achieve a funding level of more than 100% as a cushion for the next market downturn.

This in turn means that Swiss pensioners will have to wait longer for their pensions to be aligned with inflation. It is not mandatory for the majority of pension funds in Switzerland to adjust pensions according to inflation rates, as they often provide better benefits than legally required. So pension funds will only redistribute more money when they have made some more.

As we did not invest in any structured products, we have not had any direct losses as a result of financial institutions going bust. However, it is still not known to what extent the hedge funds of funds we have been exposed to have been affected. And of course we felt the bankruptcy of the financial institutions indirectly.

The members of our executive board are in regular contact with each other online to follow the financial developments. But despite wanting to rebalance our allocation, not much has changed for us as of now. We did not sell equities nor do we intend to buy any until we get the impression that markets are stabilising.

We have been trying to analyse this crisis to find out what we can learn from it but this process has yet to be completed. The only conclusion we have come to is that we should not act in a hurry. And while our hedge funds of funds make use of short selling and stock lending we do not think they are to blame for this crisis - in fact they have contributed to market efficiency.

But it is quite disenchanting to find out that we basically have not made any returns with our diversified strategy over the last 10 years, which leads to the question of whether we will eventually have to change something.