Belgium: Keeping it safe and simple
Belgium’s pension funds are erring on the side of caution as they begin the process of re-examining their asset allocation strategies following the downturn. Nina Roehrbein reports
With the post-crisis realisation that asset allocation - whether strategic or tactical - is the key to happy returns, it is top of the agenda for pension funds worldwide.
In Belgium, asset allocation has remained relatively stable between 2008 and 2009. According to Karel Stroobants, veteran of the Belgian pensions industry and independent director, pension funds did not really make use of tactical asset allocation during the financial crisis. Instead, he says, in most asset classes they merely followed the market corrections and abstained from rebalancing. “In the last six months though cash has moved back into equities,” he says.”
The Belgian Association of Pension Institutions (BVPI) reported a 40% exposure to equities at the end of 2009, compared to 44% at the end of 2006, up from 28.7% at the end of 2008 (see graphs).
Mercer reported a 50.4% equity allocation at the end of 2009, compared to 52.3% in 2006, which does not suggest that pension funds have fled the equity markets, says Jan Longeval, managing director at Bank Degroof, which has around 25% of all Belgian pension funds as its clients.
The main reason for the conservative and cautious approach to asset allocation is that the Belgian pension fund industry is very small and concentrated. Of the around 250 pension funds, only six are classed as large, says Stroobants. “The smaller ones do not have the capacity to move to more sophisticated asset allocation models or classes,” he says. “Tactical asset allocation requires sufficient sophistication from pension funds and there are only a handful in Belgium who can do that or give a specialist mandate to an asset manager who has the capacity to do that.”
Most smaller pension funds use global balanced mandates, for which the short-term tactical asset allocation is done automatically by the asset manager.
“But a lot of new money was put in equity markets in 2009,” says Kristof Woutters, pension solutions expert and head of financial engineering at Dexia Asset Management in Brussels. “Markets and pension funds very quickly regained their confidence in the asset class. This may continue through 2010 at a lower speed but will not go back to levels seen before the crisis. Belgian pension funds are, however, shifting towards other asset classes, as they need higher returns than the bond markets can
Contrary to most other European countries, the Belgian prudential supervision does not force pension funds to use market interest rates to discount future liabilities when calculating the present value of their total liability. In other words, they still have the choice between using market interest rates or the expected return on assets, resulting in almost every fund using the latter to be able to use a higher rate. However, if the average discount rate used by Belgian pension funds is their expected return from assets, that is by definition also the return they need to avoid a deficit.
Because the Belgian financial markets are relatively small and do not allow for sufficient diversification, pension funds have always been well diversified geographically in their equity portfolios.
“Most of them are diversified worldwide with a focus on the euro but with at least 10-20% in US or emerging markets,” says Stroobants.
Longeval also witnessed a sharp move towards investment grade corporate bonds in 2009, as elsewhere in Europe, spurred by attractive spreads and risk premia. “According to Mercer’s survey, the bond ratio went up from 38% in 2006 to 43.1% at the end of 2009,” he says. “This is probably mainly due to the increase in corporate bonds.” He now reports a growing interest in plain vanilla government guaranteed inflation-linked bonds due to concerns about rising inflation.
According to Longeval, alternatives have never been popular among Belgian funds. “Hedge funds are perceived as too complex, too intransparent and too expensive,” he says. “Given what happened with hedge funds and private equity in 2008, there is even less appetite for these asset classes today than there was a couple of years ago. Belgian pension funds want to keep it safe and simple.”
Woutters agrees: “There is a very limited amount going into real alternatives, such
as hedge funds and absolute return funds. However, we see more interest for other alternatives such as real estate, infrastructure and commodities. Most of the new alternative funds are UCITS-compliant funds, which may help to regain confidence in these funds as they are more liquid.”
Olivier Lafont, CEO at Fortis Investments in Belgium, says: “Alternatives in Belgium are mainly European infrastructure investments. It is almost exclusively the larger funds that invest in them, only 60% of the mid-size ones have an exposure to alternatives, while none of the small ones do. In fact, the asset allocation for pension funds below €125m was 30% equities, 53% fixed income, 10% real estate, 5.8% liquidities and only 0.6% alternatives at the end of June 2009.”
Liability-driven investment (LDI) also seems to be of interest only to the larger pension funds - KBC Pensioenfonds adopted its LDI strategy in the summer of 2007, while Amonis moved to LDI in the spring of 2008.
“Because Belgian pension funds are not forced to use market interest rates to calculate their liabilities, they do not carry a big interest rate risk on their balance sheets,” says Woutters. “Pension funds from listed corporate sponsors, though, might be interested in duration matching techniques such as LDI, because IAS19, of the revised international accounting standards (IFRS), imposes the use of market interest rates to discount future liabilities on the balance sheet of the sponsor. Flexible dynamic asset allocation solutions based on stochastic asset liability modeling (ALM) analysis will make the pension fund much more aware of the risk it is running, and they are currently much more popular than LDI solutions.”
Stroobants, who blames short-term regulations and the focus on marked-to-market for this short-termisn, adds: “LDI is a good choice to make on the long term, but unfortunately more and more pension funds are taking decisions with a short-term view, particularly company pension funds, because they are directly linked to the profit and loss account of the sponsoring company,” he says. “Maybe in a few years’ time we will also have smoothening models. However, as long as we remain focused on marked-to-market and quarterly numbers trustees are forced to look at the short sterm. The 18 months allowed to bring an underfunded scheme back to a positive funding level also make a long-term vision difficult.”
And indeed, the issue at the forefront of many pension funds in 2009 was their funding level.
Underfunded funds asked for more money from their sponsor or had to submit recovery plans to allow them time to return to a better funding level, according to Guy Lerminiaux, managing director at Petercam. They did not move to supposedly higher return-generating assets such as equities to do that, he says.
But compared to other countries, underfunding never became a structural problem. Even at the end of 2008, pension funds averaged 97% in the long-term technical provision - calculated by using the discount rate - and 112% in the short-term funding level, according to different statistics by the BVPI. Only 18% of pension funds fell below the short-term technical provision, while 33% failed the long-term technical provision. Following the market upswing, at the end of 2009, pension funds were at an average funding level of 129% for the short-term liabilities and at 112% for the long-term liabilities.
Asset allocation is also often undermined by a falsely perceived annual minimum investment guarantee for DC plans.
But the 3.25% minimum guarantee Belgian DC funds have to provide - and which was introduced with the Vandenbroucke law in 2004 - is defined to be over the long term; in other words, only when the employee retires there has to have been an average return of 3.25% over the contribution period.
“If you define the plan with the correct legal wording - a minimum guarantee over the average long-term duration of a typical Belgian pension fund - there is no problem,” says Stroobants. “But although an annualised guarantee is not what the law prescribes it is often within the mindset. And then the investment policy becomes more like that of an insurance company. Prompted by the financial crisis, some pension funds have been looking at their wording over the last 18 months and found they unknowingly had an annual guarantee.”