The Belgian pension market has been ‘living in interesting times’ of late, but the opinion of industry practitioners is that the major changes now taking place will not have a dramatic effect on the use by pension schemes of investment funds, whether the Luxembourg variety or the Belgian domiciled version, known in French as Sicavs and in Dutch as Beveks (Beleggingsvennootsch apmet Veranderlijk Kapitaal).
Though figures from different sources vary from 50 to 70%, it is clear that the majority of Belgian pension fund money is invested in collective investment funds. Belgian Pension Fund Association figures to the end of 2001 show 69.5% of assets invested in collectives, as opposed to just over 20% in direct equities and bonds.
Beveks account for 72% in number and 84% AUM of the whole Belgian fund industry and have maintained these ratios more or less over the last five years (see table 1). Table 2 shows the sector-wide breakdown of assets, though these figures include both retail and institutional funds, and clearly reflect the large and continuing appetite for capital protected vehicles among Belgian consumers.
Home-grown Sicavs have a number of points to recommend them to the Belgian pension scheme. Perhaps their most obvious advantage is the tax breaks they offer. Belgian second pillar (company or industrial sector) pension schemes are liable to withholding tax of 15% on bonds and 25% on equity dividends. This tax burden can be legally avoided by investing in UCITS, whether Beveks or Luxembourg Sicavs (though domestic Beveks have a minor tax advantage over Luxembourg funds).
The second main attraction of Beveks is diversification. As Jan Longeval, director at Degroof Institutional Asset Management (DIAM), points out, the average Belgian pension fund is tiny - around e12-13m - so direct investment is not cost effective.
Tax mitigation and diversification are the two prime reasons quoted to us by most industry practitioners for the substantial use by pension funds of Beveks. But, says Longeval, even if there were no tax advantage and the average Belgian pension scheme was huge, he would still advocate the use of Beveks because of their economies of scale and their ability to access balanced worldwide portfolios. He says: “An X-ray of a typical portfolio might reveal 1,000 different holdings. This would impose high administration costs if held direct, as opposed to the low fees within a fund. The fund also offers flexibility to move in and out of asset classes.
“Some pension schemes hold say 30% of their portfolio in direct equities because they want to be able to see movement within the fund. But with 3.5% dividend yields on European equities, subject to 25%t withholding tax, you are throwing away 80 basis points.”
The one real disadvantage which Longeval highlights is the opaqueness of the fund portfolio as opposed to direct investments. “Distributors of funds have not always been shining examples of transparency. People can’t see what’s going on, and that is a problem to some.” he concludes.
Belgium’s recently implemented Vandenbroucke law is likely to have a wide-ranging effect on the pensions industry as a whole, though the outcome for Beveks is not yet clear. The law seeks to increase coverage of second pillar pension schemes to 66% of the working population by establishing industry-wide ‘sector’ schemes.
Much more problematic is the law’s requirement that employers guarantee a 3.25% average return in pension schemes to their employees. This stipulation seems to lend itself much more to insurance-based than to fund vehicles.
Peter de Proft, chief executive at Fortis in Belgium and president of the Association Belge des Asset Managers (BEAMA) says: “In volatile markets like these, and in times of low interest rates, the guarantee is a competitive disadvantage for asset managers. In these conditions it seems likely that pension funds will choose an insurance vehicle.”
For Luc Vanbriel, head of institutional business development at KBC, there are pros as well as cons for asset managers in the Vandenbroucke Law. The law will create “a stimulus for second pillar sector funds – which must be a good thing” Vanbriel says. It also sets up tax advantaged ‘social’ pension plans, where employees have representation on the board and where there are various disability, death and waiver of contribution benefits. These will be easier to operate through funds in Vanbriel’s view.
But the big disadvantage for Beveks, he agrees, is the guaranteed minimum return requirement. He does not think, however, that it will mean insurance funds become an automatic choice for pension schemes. Vanbriel adds: “Most employers will be willing to accept some risk that returns will be high enough, and so will not go for insured plans. But these defined contribution funds will be more conservative than defined benefit funds for that reason.”
While a flexible choice of Beveks in pension schemes was growing, says Vanbriel: “Now it makes no sense to give this choice to employees because there is too much risk.” Within the funds on offer, it will pay the employee, backed up by the minimum return guarantee, to choose the most dynamic fund. “It’s like a free put option for the employee,” concludes Vanbriel.
In Longeval’s view, the guarantee requirement introduces a distortion in the defined contribution (DC) sector. “Pure defned contribution plans don’t exist any more. Because of the guarantee, they all look like DB plans,” he says. DIAM’s new protect and grow vehicle aims to solve the minimum guarantee problem in a fund framework.
It is not yet clear what the reaction of pension schemes will be to this issue, but Vanbriel fears lower returns overall as pension schemes reduce equity weightings and choose lower risk investment policies.
There is a good deal of uncertainty as to what the Vandenbroucke Law will ultimately mean for the fund industry. The term ‘grey area’ was used more than once by the industry practitioners spoken to.
A working group set up at the beginning of the year by the Belgian Association of Investment Funds and market leaders Dexia, Fortis and KBC has made little progress. The authorities had asked the industry for proposals for a fund vehicle which would be able to produce the minimum guarantee. “A very strange animal was created – technically and politically quite complicated. The plans are on hold at the moment,” says de Proft.
The adoption from next year of the IFRS19 accounting standard will accentuate the flight to lower risk portfolios. “Pensions schemes will listen more to the idea of alternative assets, such as commercial real estate,” says Longeval. He is scathing about the prospects in Belgium for hedge funds.
“There is too much money in hedge funds with too little talent and too little opportunity to sustain performance. Belgian pension funds are wary of hedge funds because of their lack of transparency.”
For de Proft, a major frustration currently is the slow progress towards UCITS III. “It is already late in implementation and we would like to get on with it. The delay is affecting the development of the Belgian market,” he says. Its advent will make life easier for the provider of institutional funds, who will no longer need to run separate vehicles for different markets. With the text currently being drafted, implementation is expected in November.
In spite of the dramatic changes which are underway, and in spite of the volatility of recent markets, “Belgian pension funds tend to be
very pragmatic,” says Longeval. They tend to hold from 45 to 50% in equities typically, and have not varied dramatically from that model in recent years.
A slight move towards bonds in 2003 has been corrected this year by a compensating adjustment towards equities. Finally, the government’s acquisition of the giant Belgacom pension scheme has had little effect on the Beveks market as Belgacom was mostly invested directly rather than through funds.