A place for equities
IPE asked three pension funds in three countries – the Slovakia, Denmark and Germany – the same question: ‘Equities are still the only asset class that can provide the returns that pension funds need to reduce their deficits – or are they?’ Here are their answers
Gabriel Hinzeller is a member of the project team for Bratislava-based second-pillar
pension fund VÚB Generali, a 50:50 joint
venture between the Generali group and VÚB Banka. It was established in the second half of 2004 and will receive its first contributions from salaries for March
“The market collapse certainly had an impact. When we began to promote our asset management fund in 2000 it was only bonds and it over-performed the equity market in its early years.
We started to offer equities after 9/11 when we expected the market to rise, and although it continued to fall we were not hit as badly as many others because at that time we were not offering technology stocks.
“Each of our three funds has separate requirements. The first, our conservative fund, is a pure Slovak kuruna bond fund that invests solely in bonds and no foreign currency is allowed.
“The second, our balanced fund, can go 50:50 equities to bonds. There is a requirement that a minimum of 50% of the foreign currency component must be hedged against currency risk because the trend of the koruna is very bullish due to direct foreign investments and foreign investors and this eats into the return in local currency.
“And the third is our equity-enhanced growth fund, which has a ceiling of 80% equities, with a minimum of 30% of the fund being invested on the domestic market.
“But we anticipate that the Bratislava stock exchange will not have the liquidity, not have enough new issues or IPOs, to cope with our requirements given the flows we expect as the funds grow, so we will probably move to 70% equities and 30% bonds.
“We have the opportunity to trade in other countries and we have had very good experience with the balanced emerging fund of our asset management arm, VÚB Asset Management. We will probably look to these areas – Latin America, China, Russia and CEE countries – to generate a really interesting return, a higher return in 2005 than blue chip indexes or other western markets.
“But we also have to be aware of the risks associated with these markets so we will only look to investments in these countries to enhance the return of the fund.
“Each client can only be a member of one fund, they cannot distribute their contributions between the funds. We expect that 90% of clients will opt for the balanced or growth
funds and people are aware that even if the
risk is higher, in the long run they can
have higher returns because of the nature of equities.”
Peter Damgaard Jensen, CEO of Danish labour
market scheme PKA which has assets under
management DKK 90bn (€12bn)
“No, it’s not the only asset class but it is very important. And generally we have a much broader way of looking at things today than we had three or four years ago.
“PKA didn’t have as many equities before the equity crisis as, for example, UK or US pension funds. Originally this was due to regulatory limitations and although some years ago we were given the right to go up to 70% of a portfolio, a smaller allocation had become something of a tradition. Equities accounted for about 45% of our portfolio in 2000.
“Initially we had decided on between 35% and 40% and when we passed that as a result of rising equity prices we decided to go on and let it rise further. We, like most others, thought stocks were going up so why step out of the market?
“And that is a lesson we have learned. We undertook a reassessment during the crash and we decided that when we were back on track we would not just return to the way it was before, that we would have to be wiser and have learned the lessons of those two or three years. And we determined that we would stick to the fact that we are long-term investors. So we have three main asset classes – equities, bonds and real estate – and they are complemented by more strategic products like interest rate derivatives. Our long-term ALM and other analyses that we have undertaken suggest that given our liabilities our equity allocation should be around 30-35%. And we have to stick to that, both when equities are climbing steeply and when they are going in the other direction.
“Currently, we are below it; the level differs between the eight pension funds we manage, but collectively it is around 30% and the funds that will have the highest equity proportion will end up with something like 35%. And then, because we do not intend to go higher, we will have a rebalancing of the system.
“We have also looked inside each asset class and reviewed whether in light of what we learned during the financial crisis we should have another mix. And we decided that we should cast the net wider. Where we had only Danish bonds, we now have emerging market, high-yield and US bonds and so on, because we realise there’s also a big risk in only having bonds from one country. It’s the same for equities, where before 2000 we didn’t have any emerging market stocks we now have a very diversified portfolio. Besides emerging markets investments we try to look for managers who have a strategy that will enhance or complement our global diversification.
“We are looking at alternatives but not seriously and we are analysing commodities. But for the moment we are sticking to the usual instruments.
“History is also a guide. But we are aware that while historical data are OK in some ways, fundamentals have a tendency to change from time to time, at least over the short run. But if you focus
to the long term you will mostly stick to the
fundamentals. However, the economy is very uncertain. There is a shift from a series of regional economies to a real global economy, and that is
historically unprecedented, so there are some new movements.”
Rainer Jakubowski, CFO of Berlin-based BVV, a
pension/insurance fund for banking and financial services sector employees. It has assets under
management of €17bn
“BVV has a guaranteed rate of return of 4% and this has a significant influence on our investment strategy. For us the question is not whether to invest in equities or not, it is first how much equity exposure is reasonable, regarding the risk of the asset class and second how to protect the capital invested.
“Equities in general offer opportunities for market-risk diversification, inflation risk protection and, of course, attractive returns. Therefore, we are convinced that equities have to play an important role in the asset allocation of pension funds provided that the maximum amount of risk has been defined and an effective overlay strategy is in place.
“For German pension funds and insurance
companies the ceiling for equities is 35% of total assets. But as a result of BVV´s asset-liability
policy and risk tolerance, our allocation is
significantly less. We stress-test equities at least every quarter to assess the effects of different bear market scenarios on our balance sheet.
“Currently, BVV feels comfortable with equities
at around 10% of total assets. This is in line with
our long-term asset liability projections as well as our short-term risk measures. On a long-term perspective we foresee equities at 10-20% of our entire portfolio.
“So we are convinced that in the long run our equity exposure will provide us with positive performance given the worldwide economic growth trend. But the problem of short-term volatility of equity returns also has to be addressed. BVV prefers absolute return-type investment solutions that avoid or limit volatility and preferably generate consistent returns, regardless of the equity market’s direction.
“Consequently, we use different types of instruments and techniques to protect our capital. One
is the use of option overlays to change risk return relations.
“Beyond that we invest in equity-linked notes with optional features and capital guarantee and BVV considers portable alpha solutions where the market risk is partly stripped out. And last but not least hedged funds, eg, long/short funds or equity market neutral funds are an interesting alternative to long-only mandates.”