Allocating Pensionskassen assets
As an increasing number of listed German companies, particularly those traded on the Dax-30 equity index, create external funds for pension liabilities, outsiders might be left with the impression that corporate pension funds are new to Germany.
Far from it. Although most German
companies have traditionally funded pension liabilities via assets on the balance sheet, external funds known as Pensionskassen have been around since the late 19th century.
Pensionskassen differ from other types of German pension administration in that they are essentially insurance-type vehicles. Like German life insurers, they guarantee not just paid-in contributions but a rate of return, currently 2.75%, on them. Generally, this is achieved through a mix of conservative investing and close scrutiny by the financial services regulator (BaFin).
Partly because of an obsession with security, Pensionskassen have emerged as a big player in German corporate pensions. At the end of 2004, the vehicles made up one-fifth of the €381bn in total assets. Moreover, multi-employer Pensionskassen launched by German insurers or even companies are competing for and winning new pension business, not least because employers and employees are so comfortable with their business model.
One of Germany's most successful Pensionskassen is also one of its oldest: Höchster Pensionskasse (HPK), a 120-year-old scheme that until 1998 only insured employees of the former chemical and drugs giant Höchst.
Since it opened itself to employers outside of the Höchst conglomerate, HPK has acquired some 250 firms and 60,000 contributing members. The fact that the pension fund is based in Frankfurt's Höchst industrial park has been a big help. In addition to the post-Höchst companies such as pharmaceuticals giant Sanofi-Aventis and chemical giant Celanese, the park is home to numerous other companies.
Assets from HPK's multi-employer scheme have swelled to €270m. This is on top of the €5.3bn already held in the old Höchst-specific scheme. The old scheme provides a pension to 110,000 employees at the post-Höchst companies (including Sanofi-Aventis, Celanese and Clariant) and pays out benefits to 46,000 retirees.
HPK chief executive Joachim Schwind notes that much of the fund's appeal has to do with its emphasis on security and transparency. "This resonates well with employees who see their corporate pension as playing a more important role in securing their retirement income," he says. "We are attractive to employers as our investment strategy is focused on minimising the risk of having to intervene to support the fund."
HPK's investment strategy is certainly geared toward security. The fund invests 55% of total assets directly in investment-grade government bonds and German covered bonds known as Pfandbriefe. Investing is done by HPK's eight capital market professionals led by chief investment officer Andreas Hilka. Hilka's team also conducts asset-liability studies on an annual basis.
To boost returns, HPK invests 18% in bond funds and 5% in equity funds. The bond funds include those that invest in European government debt or corporate debt.
Like many other German Pensionskassen, HPK also allocates a significant portion of
assets to real estate. But unlike its peers, which either directly invest in properties or, as is increasingly the case, buy into international funds,
HPK has 22% of assets tied up in building
loans. "With building loans, you get between 80 and 100 bps more in return than 10-year German government bonds and have steady cash flow," says Schwind. "The risk is also well spread around and if you need to write off a loan, you don't have any accounting problems."
Given such a safe portfolio, it's no surprise that HPK's net return for 2005 came in at just 4.8%, below the 5.1% for 2004 but above the guarantee of 2.75%. It was above the average Pensionskassen return of about 4%, which was below the 11% average for Pensionskassen in Switzerland and Austria, which raised their exposure to equities in 2004 and 2005 to take advantage of the bull market.
However, a direct comparison between Pensionskassen in the three countries is not entirely possible because of the peculiarities of the German market. Chief among these are German accounting rules (HGB) under which German Pensionskassen state their net returns instead of their market returns. Hilka, who participated in the interview, says that in fact HPK's market return for 2005 was higher.
"A comparison of the return on investments must take into account the legal and regulatory framework, which varies widely from country to country," Schwind stresses. "So, for example, in Germany the supervisory rules are more oriented to quantitative measures while in other countries the focus is more on qualitative criteria."
He adds: "The fact that we have to frequently stress test our assets as required by the BaFin also means that we can't afford to really have a huge appetite for risk."
Still, some industry experts question whether the guaranteed return offered by German Pensionskassen - which is to fall to 2.25% from 2007 amid continued low bond yields - is in the best interests of their insured.
"There is no question that the insurance-type strategy pursued by the Pensionskassen of focusing on earning the guaranteed interest rate fits the security-oriented mentality in Germany," says Erik Crawford, principal at consultants Mercer in Frankfurt. "But the insured might ask where the added value is when they themselves can get that same return or even more in money market instruments."
Moreover, claims by HPK and other German Pensionskassen that the combination of a guarantee and tight regulation prevent them from taking on more risk for the sake of higher returns do not tell the full story. The BaFin permits these scheme to allocate up to 35% of their holdings to equities and in 1999 - the year before the equity bubble burst - HPK had 30% invested in the asset class.
According to industry experts, the other explanation for the equity shyness of German Pensionskassen is simply that many of them have had to rebuild risk budgets that were wiped out by the equity market crash of 2000-03. And despite the recovery of the markets since then, they have not fully regained confidence in the asset class.
"Regulation by the BaFin has not been excessive," says Andreas Poestges, chief investment officer of Barmer Pensionskasse, a €1.27bn pension fund for health care employees. "Rather, it was more of a question of whether or not the Pensionskasse had the appropriate risk budget to raise exposure to equities," in past years.
What then are the likes of HPK to do? Well, as investment consultants and asset managers never tire of repeating, they have the option of boosting returns by employing alternatives like hedge funds and private equity, or strategies like global tactical asset allocation. Hamburger Pensionskasse, a multi-employer scheme, even scrapped its guaranteed return on some pensions to provide it with more flexibility to chase higher returns.
Yet Schwind and Hilka say that despite frequent meetings with consultants and asset managers, they have so far not found alternatives that are sufficiently convincing. "If we are honest with each other, there are hardly any alternative products that are really transparent," Hilka says. "Our challenge is that we want steady and reliable returns. But the products out there are non-transparent, expensive and hard to account for. It is therefore difficult for us to justify investment in these products to our supervisory board and insured."
However, Hilka notes that HPK's attitude is due to change. "Five to 10 years from now, we will be discussing alternatives far more intensely," he says. "By then, I can't imagine awarding plain-vanilla mandates for European equities or bonds. That's because the alpha that is generated by these managers is just not big enough to justify a big engagement."
Despite a strong do-it-yourself approach, HPK has shown a great openness to new ideas from the investment community. In the 1990s it was one of the first pension funds to hire a global custodian - JP Morgan Chase - instead of relying on a local bank for clearing and settlement.
HPK was also one of the first German schemes to switch to a master fund for its bond and equity investments. In a master fund, a single service provider, in this case Deutsche Asset Management, performs all back-office administration of an institutional investor's funds, such as reporting and risk monitoring. The claimed benefits of the process are lower costs and greater transparency and risk management. Since Germany's implementation of the EU pension fund directive last year, HPK's multi-employer scheme can also build on its growth in Germany by expanding elsewhere in the EU.
But Schwind says that this option is currently not attractive because of the very diverse social, labour and tax laws in the region. "We also have plenty of room to grow in Germany right now, so doing business elsewhere in Europe is not planned for this year," he says.