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A long and winding road

Despite a number of different pension schemes available to employees, the overwhelming majority of the French pensions market is still based on its underfunded pay-as-you-go (PAYG) system.

Phillip Silitschanu, senior analyst at US-based research and advisory firm Aite Group, puts this down to a French mentality that still believes in a government safety net, especially as a third of the population works for the government or a government-related agency and has no incentive to invest in other retirement products.

However, private and state pensions find common ground in their conservative, fixed-income-driven asset allocation.

Multi-employer pension fund UMR Corem has two thirds of its assets in bonds and absolute return, with just over 15% invested in stocks, 10% in real estate and 5% in hedge funds. But it was the smaller allocations that performed best and helped achieve an overall 10.15% net return in 2006.

"Last year's best portfolio was real estate where we made a 33% net return due to some opportunistic sales on Parisian housing," says UMR Corem's chief investment officer Vincent Ribuot. "The second-best contributor was European equity with a 20.64% return, but we were also pleased with the 5.45% net actuarial return in bonds." He adds: "We do not buy stocks when the yields go up - so right now we are in the process of buying bonds."

The French reserve fund (FRR) achieved net returns of 11.2% in 2006, when it invested 62.2% in equities, 26.3% in bonds and 11.5% in money markets. Its €4.6bn increase in assets on 2005 can be attributed to €1.5bn worth of endowments received in 2006 and €3bn to management performance.

"Our performance is mainly a result from the excellent return on equities, particularly in the euro-zone," says FRR executive director Antoine de Salins. "Despite the sudden correction of the stock markets in the second quarter, we continued to leverage our equity investment, which we bolstered at the end of the spring. The performance of our bonds investments was clearly impacted by rising interest rates in 2006, particularly in Europe. However, globally the yield remained positive on an annual basis thanks to the very gradual pace of our investments in this asset class."

Caisse de retraite CRPNPAC - a mandatory, additional first-pillar PAYG pension scheme for flight personnel of the airlines and aviation industry - saw a global 9.5% return in 2006. This was a result of an index-like 21% return in its real estate portfolio, which makes up 19-20% of CRPNPAC's assets, and a 6.53% performance in securities, which make up 80.5% of the portfolio.

While the strategic real estate allocation was constant between 2005 and 2007 at 20%, CRPNPAC's strategic equity exposure increased to 34% in 2007 from 30% in 2005, while strategic bond allocation fell to 36% in 2007 from 40% in 2006 and over 47% in 2005. There has been an average tactical overexposure of 2% in equities and a similar underexposure in bonds for more than a year now.

Meanwhile, money market investment rose from 3% in 2005 to 5% in 2007. CRPNPAC's chief executive officer Etienne Stofer says: "In 2006 we had returns above the relative index in each of our asset classes except in European equities, in which we were equal to our benchmark. We were also significantly over the index in all asset classes during the first half of 2007, which is our short-term goal."

For UMR Corem and CRPNPAC, the underachievers of 2006 were world stocks, in particular Japanese and US equities due to currency weakness.

However, CRPNPAC is still well above its 15-year objective of inflation plus 3% net of fees and taxes.

"Our future objective is, as before, diversification and liability-driven investment," says Ribuot. "Opportunities lie in the creation of new products, while the looming insurance regime Solvency 2, the costs of new capital requirements and the ability to meet liabilities on a long-term basis with the help of a more realistic discount rate are challenging us and may lead to policy changes. Unfortunately, we have a very constraining discount rate in France, which leaves us underfunded under French law. With the help of our own mortality table, we have also been closely monitoring longevity since 2003."

CRPNPAC introduced absolute return as part of its strategic asset allocation in 2006. The initial level was 3% but has since increased to 5% and is set rise to 8% in 2009. It also plans to reduce its real estate exposure within a decade because it wants to increase liquidity and the market is approaching its peak, says Stofer.

"We are the exception compared with other PAYG systems in France, as we have strong assets with regard to the level of pension we serve every year," he says. "As we are a small scheme and our demographic equilibrium will deteriorate in the next decades when more people retire, we need to have a long-term view of 10-25 years. A scheme reform introducing a later retirement age would allow us a longer horizon and be a major opportunity to enhance our equity portfolio. But an outperformance of CRPNPAC's 15-year objective would also help us to allocate more space to equity and other long-term investments."

FRR faces three main challenges in 2007. First, it wants to continue diversifying its investment strategy as decided by its board last year. It wants to invest in private equity, for which it just finished the manager selection, as well as in commodities, for which it intends to launch an RFP during the autumn. It is currently reflecting upon the precise financial strategies and investment structure it would like to retain for real estate and infrastructures. Second, it wants to see its role and funding consolidated during the national debate on pensions reform scheduled for 2008. And third it intends to continuing to build its identity as a responsible investor.

Silitschanu says that the best private pension funds can do to gain more members and assets is to lobby the government for rules. Another incentive is to set up a savings account scheme where the investors can temporarily pay in money while awaiting regulations from the government, which allows them to then transfer the money into the most appropriate scheme, he adds.

But Silitschanu explains that some products can circumvent the uncertainty of tax regulations. "Insurance products in France are very favourable options when it comes to taxes because the government does not tax insurance products as heavily as other retail or investment products," he says.

But he believes that over the coming years the new French government will make the available investment and retirement products more attractive.

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