A force for stability
DB works for us, says Tractebel. Fennell Betson reports
The three pension funds in the Tractebel group are classical defined benefit (DB) schemes sitting astride Belgium’s generous first pillar, as befits one of the country’s largest employers. “That we use the DB approach is not surprising, given the stability of our workforce,” says Hervé Noel, who runs the schemes as part of the treasury function of the group, which includes the country’s gas and electricity utility companies and associated businesses.
He adds: “Having experienced, competent people has always been a key facet of the industry, where the concept of public service is still strong.” Two of the group’s three funds go back nearly 50 years, while the most recent was started 40 years later. Having three funds reflects different pension schemes within the group and, to an extent, the different involvement of trade unions. The two largest funds do not split on industry lines, but on the white collar/blue collar demarcation, with the third fund for all other group companies outside the gas and electricity ambit.
Around 17,000 people are covered by the three funds. Like many other Belgian schemes, members chose to take the benefits not as pension but as a lump sum at retirement. Tractebel reckons that typically, where those retiring have a choice between pension and cash, 90% to 95% take the lump sum.
“Basically, this is because the state pension is pretty good in Belgium and by that point in their lives, most members will own their own homes,” says Noel. But how pensions are taxed and the flexibility of the lump sum are also decisive factors.
Employees expect to get around 60% of their average career earnings after 45 years, up to a ceiling of around a maximum E35,000 a year from the social security pension, though there have been moves to reduce this. “What the second pillar does is to bridge the gap between average and final pay, at a higher level than 60%, and frequently, for less than 45 years’ service. Typically, it is 70% of final pay for a 40-year career.
“When it comes to the investment side, the three funds have the same asset allocation and strategy and share the same asset managers,” he says. The withdrawal of lump sums instead of paying pensions does not have any noticeable effect on the investment approach. “We still have a positive cash flow with people joining, and the investment horizon is still long-term.”
More than two years ago, the funds organised an asset allocation study through a consultant, with the aim of assessing the long-term pension financing implications for the group. The longer the study projections periods were, the greater the number of possible scenarios on whether the scheme would enjoy contribution holidays or face much higher contributions. “If you diversify adequately across asset types and managers, if you choose a sound financing method, you are very likely to remain and operate in acceptable conditions,” says Noel. The study pointed the funds towards increasing the share of equities in the asset mix without increasing their risk profile significantly. Although a strategic allocation was not spelled out in the study, the funds opted for a strategic asset mix, with 52.5% in equities, 35% bonds, 7.5% in real estate and 2.5% each in alternative investments and cash. “The only movements from these strategic bands are variations of plus or minus 10% around these limits. These tactical shifts would arise from concerns about the outlook for particular asset classes,” he says. Any rebalancing between asset classes is normally done quarterly, though there is provision to do it more frequently, if circumstances warrant. Of the equity portfolio, some 65% is in Europe, covering both Euro-zone and pan-Europe, with a definite overweight in Belgium, though much less than some years ago. “We do not go so far as saying we do not want any domestic equities as such. For bonds, the picture is slightly different, the euro is the reference currency and 85% is in euro-denominated bonds and 15% other currencies.”
The balance of the equity is split between the US, Japan, the rest of Asia and emerging markets and the 10% movement about their allocation weight also applies. “Each of those regions has an allocation weighted in terms of not just market capitalisation, but also GDP.” But he points out that in exceptional circumstance – as occurred in 1998 in Asia – the portfolios were more than 10% below their normal weightings there. “We don’t just follow these blindly.” Such an allocation leads naturally to specialist managers, he says. “We could give it to a global firm, but we do not believe that any one manager has all the capabilities across all markets or asset class.” The funds do some internal management but this is confined to euro-bonds and real estate.
“It is important to keep close to the markets by doing some things on your own, but for the rest, we strongly believe that asset management is not our business and even with E1.2bn in fund assets, it is not enough to take on asset management. So we confine ourselves to strategic allocation and the rebalancing issues, selection and monitoring of managers.”
Like most Belgian schemes, the investments are largely done through mutual funds for tax reasons. “It is the only way we have of compensating for the tax advantages of life insurers, since they can recover the withholding tax,” says Noel. Even if some of these funds are heavily institutional, retail investors cannot be prevented from investing too. Our real concerns are that these funds are managed with a long-term view and risk tolerance. We do not want a manager to change his style, just because the past 12 months he was under the benchmark. But a retail investor won’t look at it in the same way. He looks to absolute performance, while we look to relative.”
Disposing of managers may be much easier through investment funds than with segregated accounts, but at Tractebel it is not done lightly. “Where there is a breach of one of the essential components of the agreement between the asset manager and the pension fund, which can be in terms of the prospectus, written separately, or even verbally during a representation, and things are not turning out the way we expected even if it is not necessarily affecting performance, it could still lead to the firing of the manager.”
He adds that institutional investors should be prepared to accept managers’ underperformance when the reasons are clearly identified and coherent with the manager’s policy statement or if adequate steps are being taken to rectify the position. “We use a whole combination of information sources, with many contacts with managers and ‘would-be managers’, and services such as Fund Research.
The funds have three multi-manager arrangements, of which two are equity managers and one a fund of hedge funds. “We like them because it provides diversification of risk and styles, through professional advice and selection. But sometimes the reality turns out to be different and you should not believe that that approach is going to work every time in every market.”
The alternative investment involvement commenced two years ago. “We started with just 2.5% in alternative investments which is not a lot, but within that allocation we diversified as we wanted to avoid bad surprises, which could be linked to concentration on few managers. We include private equity, hedge funds, small caps, emerging debt and could cover other types of assets. In fact it is everything that is not part of the standard allocation.”
In time, Noel sees the alternative side increasing as it acts as a diversifier. “We can afford the short-term volatility, and the illiquidity aspects need not be too much of a problem for pension funds, provided we get a premium for it.” Like other Belgian schemes with a reasonable equity content, the Tractebel funds have done well. “Many plans are in the position to lower their contribution rates,” says Noel.
He sees the continued diversification into euro bonds, corporate and other types bonds from government bonds. Before the euro, the domestic bond allocation was invested almost exclusively in Belgian government bonds. “Now the market is changing quickly, you see more corporate issues, and the supply of government bonds is going to be limited.” Noel says pension funds should not forget the spreads between different bonds are to reflect the different risks involved, such as the difficulty of disposing of them in panic market conditions.
“We appointed two corporate bond managers more than a year ago. But we are not going to dispose aggressively of our Belgian bond holdings as they provide interesting spreads. Diversification is nice, but not at any price.”