Building on strong foundations
The Bayer-Pensionskasse ranks among Germany's oldest and
most go-ahead.Fennell Betson reports
Last year the Bayer-Pensionskasse(PK) celebrated its centenary, ranking it among the oldest of Germany's corporate sponsored schemes and one of the foundation stones of employer pension provision in the country. With around DM10bn ($6bn) in assets, it is the largest PK with a single-sponsor - the huge international chemical group.
The PK is just part of the pension provision in Germany by Bayer," points out Jürgen Bader, who is chief investment officer based in Leverkusen, the worldwide headquarters of Bayer. "The company runs a book reserve scheme additionally." But the PK provides the basic pension provision of the scheme, which is both compulsory and contributory for employees. Beyond a certain pay level, extra pension will come from the book reserve component.
"On the benefit side we describe the PK scheme as being a hybrid, with elements of defined benefit (DB) and defined contribution(DC)," says Bader. The employee contributes 2% of pay up to a specified limit and the pension is related to these contributions, but the employer guarantees the payment of this level of pension. Bader says he and his colleagues get heavily involved in the discussions about full DC coming to the German market.
The scheme has a high number of active members, currently around 62,000, as against 36,000 pensioners and around 11,000 deferred pensioners, but it has been caught in the strict Bayer policy of shedding staff. "This has will undoubtedly have some impact on the pensions financing side, since we had made our earlier assumptions on growing employee numbers." With early retirements, the numbers of pensioners has jumped by nearly 25% over the past four years, so that for the first time pension payments exceeded contributions.
"Nevertheless the fund is in a comfortable financial position, as the inflow of investment income and contributions is still well beyond pension payments. We have made forecasts and know that over the next 20 years, the balance between these two flows will cause us no concerns."
Bader watches with sharp interest the discussion among the other big German groups about the external funding of pensions. "Tremendous liabilities have been built up over the last decade and there is an uncertain future if you invest these assets in your own company. I know many chief financial officers in German industry are becoming increasingly aware of the risks they take in that they might have to cope with much higher outflows in the future and to have to generate these sums within their business." Also, he questions the conventional view and asks whether there is the same need as in the past to have these internally available funds, given the high equity ratios in most German groups currently.
The main obstacle to enlarging corporate pensions is the inflexibility of the different pension structures available. "The key word is 'flexibility', the problem in Germany is that once you set up a scheme you are bound to it, even if you cannot afford it in the future," he points out. "But with us the discussion is about making pension provision more efficient and somewhat less expensive, in order to increase the global competitiveness of German corporations." Among the factors adding to Bayer's costs is having to pay payroll taxes on pension contributions to the PK. Implementing tax incentives and pensions legislation reform await further political decisions.
Though over its long history, the PK has found itself operating under different legal environments, its current mould is that of the insurance regulations which govern the running of PKs, often regarded as mini-captive life companies, particularly as to the investment rules. Here, Bader has no problems: "In my view these investment rules allow us a satisfactory level of flexibility." The current permitted level of 30% for equity in PKs, which can be increased to 35% effectively by the so-called 'öffnungsklausel', is sufficient for their purposes. "At Bayer we are up to the 30% limit and we are one of the few PKs to be so. But with actual volatilityof the equity markets, discussions on increasing this are at least temporarily sensitive."
The strategic asset allocation is firmly on the shoulders of the scheme. "We do not believe that external managers should have this degree of power, to control the shifts between asset classes." This is one reason why in the nine years that Bader has been with the scheme, there has been the move from balanced to specialised mandates. "We have no balanced portfolios now." To get the structure right meant implementing asset/liability studies and taking advice from external consultants. "But at the end of the day, it comes back to being the responsibility of the PK's board of trustees, who probably sees it as my role to come up with initiatives on this side."
Currently, around 13% of the portfolio is in real estate investment. "Formerly, this was completely invested directly in real estate, but we took the decision some years to go indirect as this makes it much easier to deal. We began with an actively managed portfolio of real estate investment trusts in the US and more recently mandated an external manager to build up an active portfolio of real estate companies world wide." However, the investments are still largely direct, with property also in the UK and the Netherlands.
Also, the fund has a big commitment to providing mortgages to Bayer staff, this amounts to 25% of assets. The fund has an 18% asset tranche in the famous Schuldscheine investments. These, explains Bader, are "non-traded and non-listed" loans, which when granted to banks, can be regarded as fully secured since they are covered by the mutual guarantees against default operating in the different parts of the banking system, frequently involve a state guarantee. "There is little liquidity in these papers. Since they are accounted for at cost, they are not affected by interest rate changes."
He adds: "We normally get a premium rate of return on these, which makes them very attractive and because of their long term nature we can afford to buy and hold these instruments even though they are not liquid as we are certain that we will not have to sell them."
These three portfolios of mortgages, direct property and Schuldscheine investments are managed internally. "When we come to investing in tradable securities we believe we are very much better off to do this all externally."
Here, Bader has a simple, but irrefutable philosophy: "You are only justified in taking over as investment manager yourself if you can assume that you will be more successful than all your competitors." Something of a tall order, it has to be conceded. "We are better employed concentrating on finding the best players in the business."
The PK's fixed interest portfolio consists of the 18% Schuldscheine managed in-house and the 17% in domestic and international bonds through Spezialfonds. They can be regarded as complementing each other, he says. "The Schuldscheine asset class with its 'buy and hold' approach may be regarded as a kind of passive investment."
The other bonds are invested in active portfolios across four external managers. "They are to be a counter balance to our in-house passive approach." But in going the active route, Bader says the fund avoided putting all eggs in one basket by sorting out different style approaches for example, between traditional and a couple of more quantitative styles.
When it came to passive equity investment, the decision was to outsource. "To manage in-house does entail expenses, such as having a custodian and in-house accounting and administration. But we found that when we discussed the matter with asset managers, they offered to provide it at a fee equivalent to that for the custodian services alone. While we could have easily done it in-house, on balance there was no doubt it was more attractive to go externally, in particular, the ability when investing through Spezialfonds of accounting for just one unit price, as opposed to the number of different underlying securities in a portfolio."
The active and passive debate is one that the Bayer PK has been involved with for the best part of a decade, and where it has had a number of different phases. "When we started restructuring both our bond and equity portfolios in the 1990s we had a high proportion of passive. But new mandates since then were on an active basis which meant the ratio of passive declined." The move to Euroland, which is currently becoming the new domestic asset class has meant another re-adjustment in the active to passive ratio. "When this is completed we expect the split in the ratio to be 50/50."
On the equity side most pension funds start from the position of having their biggest exposure to their domestic market. "So your first solution is to optimise your domestic portfolio. It was here we came up with the idea of having a style diversification approach. By this we do not mean the usual Anglo Saxon of value and growth, but choosing between active and passive and on the active side between quantitative and qualitative. This provided us with a range of choices."
Coming from the traditional bottom up selection being offered by most German managers, Bader says: "We became fascinated by the very disciplined approaches being taken to investment decisions, having once understood the algorithm of these methods designed to ensure that only one right selection decision could come out of the process."
What he really liked was the opportunity to look into a disciplined decision-making process regarding investment and understanding it. "This was not relying on stars and personalities and perhaps irrational investment decisions. We wanted to bring in as much rationalism and discipline when our large sums money were being invested."
When it comes to the international side, Bader says the PK believes in diversification. "We still work on the basis of low correlation between the different regions and we have benefited from spreading our international investment. Our aim was to implement country and regional approaches." At the beginning of 1999, we expect the equity portfolio to be 50% in Euroland, 10% the rest of Europe and 40% rest of world.
The PK has been successful in the returns achieved, particularly with one that out-performed all other German equity portfolios on the basis of such quantitative method. The overall return obtained from the full portfolio last year jumped to 9.1%, compared to 7.4% pa for the previous four years. This was due to the strong equity outperformance in 1997, says Bader.
The amount invested externally is done though a range of 10 Spezialfonds, six investing in equities and four investing in bonds. These have a number of advantages as the investment vehicles for institutions, says Bader.
"Using existing Spezialfonds can be regarded as an acceptable way of bringing in the expertise of foreign asset managers, who have been cautious of entering the German market because of the costs of setting up a KAG investment management company for themselves. We found that there was a way to be able to make use of their expertise, by making them external advisers for sub-sets of the Spezialfonds."
This system now works very satisfactorily, he maintains. "In the early days there severe signs of scepticism on the part of the German asset managers running Spezialfonds, who did not find it amusing that they were not gaining mandates for foreign investment and their clients were bringing in foreign advisers to their funds. But this co-operation is now working well."
But is there a trend back to fundamental techniques in Germany and in Europe, for that matter? Bader notes that "everyone is arguing that that bottom up is to become more important in the in the effort to outperform. So huge organisations are being set up with more analysts and more resources. My feeling is that asset managers think they have to find that extra something and are looking beyond the quant and other rationalised approaches available in the state of the art product. The aim is find information advantages by spending incredible amounts of time on the particular stock."
A danger he thinks is that with the change to Euroland, the focus will just be the largest companies and that the smaller companies will become neglected by analysts. "These will be totally given up to whoever - I do not know."
A trend is developing to use a master custody services provided by major specialist custodian banks, particularly where institutions have a number of Spezialfonds with a range of managers in order to co-ordinate the reporting and so on. Bader is not impressed. "We have already solved this problem some years ago simply by setting up a computer link to all our Spezialfonds providers obtaining the data from them in the format we need." The additional fringe services that custodians offer, such as securities lending, are not of interest to the PK. For example, because of insurance regulations, securities lending is heavily restricted. He also points to the recent severe erosion of returns available from lending.
The PK has appointed a performance measurement services provider in order to obtain more in-depth information from the PK's data. When the fund recently established a currency overlay programme "it was challenging to get this integrated with the performance measurement report so that we could have the overlay contribution clearly identified, which we managed to do". Regarding, the currency programme, Bader says the decision was to adopt a style approach once again, mandating three managers each with a different method. "In the long run, the benefits from currency management may be questionable, but shorter term if you get the swings and timings right there can be significant additional returns and this is what we are looking for," he says. "Even in the eight months or so, which is much too short to make judgements, it looks as if there will be tremendous variations in results, with the more quantitatively driven seeming to be more promising."
However intriguing he finds currency management, Bader is much less sanguine when it comes to tactical asset allocation, where the PK has had a manager running a strategy for a couple of years. "So far the results are not encouraging. The major component in adding value is getting the timing right, but I doubt that there are efficient strategies in terms of asset class or regional allocation to get this done properly."
So even for a fund with a 100 year tradition of in-vestment, there is no surefire way of guaranteeing returns, in fact, as Bader would readily acknowledge, it does not become any easier to achieve them - but if it did, then where would the challenge be?"