Nicholas Sobczak, FRR's new CIO tells George Coats that he wants to show the French how useful the financial markets can be in securing pension promises

Nicolas Sobczak had a spectacular start as the new CIO at the French pensions reserve fund, the Fonds de réserve pour les retraites (FRR). "I started at a time of market turmoil," he says.

Sobczak's mid-August arrival at the FRR coincided with the markets' growing awareness of the full implications of the US sub-prime crisis.

But did the downturn have an effect on the FRR? "We don't have exposure to those very volatile products, to any dynamic money funds that are difficult to value," he says. "Indeed, our asset managers were also underexposed to the financial sector in their mandates, and on a tactical basis the allocation was quite prudent.

"But while at this stage the pure liquidity crisis has not had a direct impact on us, the impact on global flows and global assets is slightly different and we will have to manage the situation as it unfolds."

But in some ways it is fitting that Sobczak arrived at the FRR with a bang. An economist, he is only the fund's second CIO since its formation five years ago, and he has something of the new broom about him. The FRR answers to France's ministries of finance and social affairs, and for all its role as a driver of new ideas into the somewhat unadventurous French institutional investment industry, it still has the air of a civil service-led body.

And while Sobczak started his career at the ministry as an economic forecaster and modeler, he comes to the FRR from Goldman Sachs Paris where he was an executive director and a member of its economic team with responsibility for the macroeconomic analysis of the euro-zone and its interaction with financial markets.

So how is he finding his new working environment? "Yes, the governance is pretty much public sector," he says.

"But I'd been in Goldmans for seven years, and it was always about the economy being up and down and down and up. Consequently, I thought it was time for me to get exposed to asset allocation. The subject is really fascinating. Suddenly you find that there is a way to show to the whole population how useful the financial markets can be to pursue an objective, which is basically to ensure a pension, without any prejudice. This is important in France because rightly or wrongly French people have the reputation of being against markets. So here we have really a real experiment, a social laboratory, because in our board we have representatives from the trade unions and employers, parliamentarians and people from the public sector. And they all together decided to put 60% of our money into stocks, and a good part of that is abroad, which is something of a revolution for French people."

Before he joined, the FRR mapped out a new investment approach. Is Sobczak comfortable with it?

"The new strategic allocation was validated by the board in May 2006 and we are still implementing it," he says. " We aim to have 10% of the portfolio in alternative assets. And yes, we need to invest in the new asset classes, which we defined then as commodities, infrastructure, real estate and private equity, and also to develop in emerging market debt and equities. We are already investing in private equity through a fund of funds with our asset manager, although the movement of the money may take between three and four years depending on the state of the market. But in this case the market timing may not be so bad as in a time of crisis there might be some good deals to do. We might be lucky on that front.

"We launched a RFP for commodities, we are still conducting research into real estate and hopefully we will be invested next year. We are still deciding what vehicle to use when investing in real estate. It should be professional but we still have to work on what kind of instrument we want to use to get the exposure. Our idea is always to be invested on the purest asset class, we want to catch the beta only. And then infrastructure could also be a big project; that's probably where we are the less advanced at this stage. But these are the most pressing issues.

"So these are the important assets we intend to grow. It takes time to devise the mandate, take it through the public tender system to ensure that all risks are managed and so on. But I hope it will be completed by the end of next year.

"In addition, we have to continue to think about the global structure of the allocation. The FRR will mark its fifth birthday around the beginning of 2008 so that will be an opportunity for us to review exactly what has been done and to assess exactly what we have learned, especially about our external mandates. And then we must consider what it all means for our actions - how we will structure products - in the future."

That is what Sobczak has inherited. But does he want to make any changes?"

"First, I think it has been a huge success," he says. "But I want to be sure that we can show we can get market performance at low cost because of the way we operate, because of our size and because of the mandates that we can negotiate. And now that we are out of the start-up phase we are at a more mature time to reflect on what we have done, to say that maybe we can rationalise the system so that we don't spend too much time on some elements. For example, if it's easier to get a passive mandate on something let's keep it passive and devote resources to places where we are sure we can generate some added performance.

"So maybe we have to think over the whole system to understand where we are able, given the constraints that we impose on asset managers, to find some alpha."

here will the 10% earmarked for allocation to alternatives come from? "We want to diversify, so it will be taken from fixed income and cash," says Sobczak. "We will have 60% in equity, 30% in fixed income and 10% in alternatives. And we could change it further thereafter, we could possibly increase the diversification."

And given current market conditions, is the commodities allocation for diversification or real return?

"We buy the diversification story more, that is we introduce new assets because we believe they provide diversification from stocks and bonds. But we are happy if there is a real return story, especially in those circumstances where, for example, you could have an unexpected inflation shock with both stocks and bonds falling and hopefully commodities going up.

In the past we have seen such episodes. In six of the eight major stockmarket downturns commodities were up, and in all major bond crashes commodities were up as well. However, we are not really running after real returns with commodities. If the idea behind investing in commodities is to buy China there are better ways to buy China than through commodities; that's not why we're buying commodities.

"So we are trying this new asset class and seeing how it works. The way we invest initially is mostly passive and then at some point we may try to be more active. But at this stage it's really getting exposure to the asset class."

And how will the FRR respond to a market downturn? "Obviously we have to manage expectations," says Sobczak. "So far the FRR's track record has been good - our performance annualised since the start is 10%. However, we have to manage it so that people don't get used to these extraordinary returns. On the contrary one of my roles is to explain that at some point the market will be less favourable and we might have years where the assets don't grow so much. And then it will be interesting to see how the general public reacts"

The FRR's approach has already had a major impact on the French investment industry. Since it began operations the FRR has acted as a trailblazer for the French institutional investment sector, being the first to put substantial mandates to the global market, invest in certain asset classes, including such a substantial allocation to equities, and to explore approaches like SRI.

"I think FRR is seen as a reference investor," says Sobczak. "But we are not setting trends in terms of fashion, there are others to do that, but we set a reference. But this should not lead the rest of the industry to be less diligent about the way they invest because at the end of the day they are responsible for their own actions."

And the FRR is more fortunate than other market players. "We have no liquidity constraints so at a time of financial turmoil it's useful to have an investor that can look at all the consequences and all the positions that are risky and bring some stability to the financial market. We don't have to run with others to rapidly liquidate a position in a way that would precipitate a complete collapse of the market. So I think that being a long-term investor, being able to hold a position and take a risk because we know we are not worrying about the long run, is a crucial function.

"As a long-term investor we are able to bear the risk and then we make money doing that."

Next year sees France's Rendez-vous with Pensions, the first of the five-yearly reviews of the pensions system following the reforms of 2003. Although the rendevous is not directly linked to the FRR, its creators saw it as playing a key role in supporting the reformed state pensions system by helping to offset future budgetary pressures arising from the impact of an ageing population.

However, although the government of Lionel Jospin expressed a wish that the FRR be financed by the proceeds from privatisations and other state sources and that the money be invested, it failed to define the sources in law. As a result, little of the privatisation receipts gained during the previous government - which oversaw the biggest post-World War II sell off of French government assets - found their way to the FRR.

So what does Sobczak hope from the rendezvous? "We did get some privatisation money," he says. "But another valuable source of our income is part of the tax paid on income from capital gains. So on a regular basis I would say that we have at least €1.5bn a year.

"But more than just having higher funding, what I really hope we get from next year's discussion is to be able to know what are our true liabilities. At the moment we don't know what they are, and it is very difficult to do an ALM if you don't know your liabilities. If you cannot establish where you have an inflation liability in your portfolio and whether you have a longevity risk, you can't really have a liability-driven approach. And while I don't anticipate that we will go into an LDI-type organisation structure at this stage, our strategic allocation is not static. It's supposed to move every two or three years so obviously it will depend on what we will have to do with the money. So we need some clarification of what exactly we are here for. Right now we don't know exactly what we are supposed to finance. Basically our mandate is to do ‘as much as you can by taking moderate risk by 2012 and then we'll see', but now we have to be more precise. However, that will be a very technical debate and that's where it will be really difficult."

But will the politicians, who in the past have shown a disinclination to participate in technical and difficult debates, really listen?

"The way to impress policymakers is to have an impact on general public opinion, that's the way it works," says Sobczak.

"My personal opinion is that the FRR has to be better known beyond a circle of specialist politicians, it has to be known by the general population and the young active people because the FRR exists for them.They must feel that they own it, that it's taking care, even if only for a part, of the public's future. The way to get politicians interested in the FRR is because the general population is interested."