Belgian pension funds returned 6.7% in 2013 on an aggregated net basis according to data from the Belgian Association of Pension Institutions (BAPI). This is good news for hard-pressed scheme sponsors and signifies that returns are closer to their long-term average. The comparative return for 2012 was 21.1% and -0.7% for 2011.

Further data from Mercer, measuring the median annual investment performance of a more limited universe of 35 leading Belgian pension scheme portfolios, shows net returns of 9.6% for 2013; BAPI data is more comprehensive, covering 208 schemes.

“The second pillar has withstood this market volatility very well,” says Philip Neyt, chairman of BAPI. “The system works, although the price for it must be met.”

The BAPI does not give an analysis of bond portfolios, but Mercer’s survey distinguishes between government bonds, corporate bonds, including investment grade and high yield, and emerging market debt. In its universe, euro-zone originated government bonds accounted for 63% of all bonds held at end-2012, declining to 59.8% at end-2013. Corporate bonds rose, although hearsay suggests that the shift from government to corporate bonds has been much larger in the BAPI universe, and KBC Pensioenfonds has virtually disinvested from government debt as long term yield curves turn upwards (see panel).

“We are seeing a shift to higher yielding asset classes. Both DB and DC schemes are looking to reduce interest rate risk,” observes Kristof Woutters, head of institutional investment at Dexia Asset Management, who says that the relatively small size of many portfolios places practical limits on their ability to reduce interest rate risk. “Only large funds can afford a derivatives overlay; the smaller ones have to choose real assets, like high yield bonds, to reduce this risk.”

The average asset allocation for the BAPI universe has shifted over the last six years from 40% in equities and 40% in bonds, to 36% in equities and 40% in bonds in 2013. Over the intervening years, the average allocation to bonds rose to as high as 53%, while equities fell to a low as 34%, in 2011.

The average asset allocation of Belgian pension funds fluctuated over 2013. Much of this was due to market movements, but it could indicate pension fund boards are aware of the need to adjust their asset exposure against funding requirements and short and long-term regulatory funding ratios. In particular, ‘minimum reserve’ funding ratios, which measure assets against what amounts to a ‘wind-up’ test, must be funded by the sponsor within a year if they are negative.

Most portfolio allocations are through mutual funds, which comprise 71% of all assets, with the rest in directly held investments. The fund provider is often part of a financial services group that offers the scheme (and sponsor) a full repertoire of services, including custody/depositary, cash management, fund accounting, and trade credit. This raises questions over conflicts of interest on the part of the provider. “There are no Chinese walls between the pension scheme boards and the main boards of the sponsors,” notes Dirk Kemkers, a senior consultant at Mercer in Belgium. “Often the finance director of the sponsor will effectively be in charge of the pension scheme.”

The number of insurance companies prepared to offer the 3.25% guaranteed rate of return may diminish as their balance sheets come under pressure due to Solvency II. “The biggest insurers, like AXA, have sufficiently robust balance sheets but many of the small and medium sized insurers may not,” warns Renaud Vandenplas, a director at BNP Paribas. “The IORP Directive threatens to collapse discount rates to a liability-based calculation on scheme funding. This could be expensive.”

Meanwhile, there is a debate over the affordability of the second pillar and opinions differ sharply. The affordability of DB schemes depends on the discount rate chosen for scheme assets, effectively an assumed growth rate. A high maximum discount rate of 6% is permitted for minimum reserve or wind-up reserves, with a lower rate for longer term reserves to meet longer term liabilities.

Most schemes use rates under 5% for long-term reserves. These are negotiated on an individual basis with the regulator. “Most DB schemes are not really sustainable,” says Woutters. “They have been using higher discount rates, near to 5%, than market yields. In reality this performance will be difficult to achieve.” Others, like Neyt, do not see a problem.

There is change evident on discount rates. “Many pension schemes are reducing their rates to 4-4.5%,” observes Jan Longevaal, head of institutional portfolio management at De Groof Asset Management, one of Belgium’s biggest asset managers with assets under management of €30bn. Nevertheless costs are rising for the sector. “The result is a reduction in the number of schemes, which is unfortunate, although industry wide and multi-employer schemes will gain members,” believes Hugo Lasat, CEO of institutional asset management at Petercam.

Discount rates may be squeezed lower, but it would be ungracious not to acknowledge Belgium’s success in building second pillar provision. “Over the last decade, the number of employees in occupational pension schemes has doubled and the membership of schemes quadrupled,” points out Neyt.