Challenges and opportunities ahead
IPE asked three pension funds: ‘What challenges and opportunities will you face in 2009?’
Marinos Gialeli, general manager at the Hotel Employees’ Provident Fund in Cyprus, which has invested assets of €260m
The year 2008 was extraordinary and like everyone else we have learnt our lessons.
That is why going forward we, like many other big pension funds in Cyprus, will have to reconsider our risk reduction measurements and rebuild our asset allocation.
Our consultancy, Hewitt, is already in the middle of preparing an asset liability management (ALM) study for us, which is set to come out early next year. We will then have to integrate it into our new investment strategy.
Opportunities may present themselves on the equity side in 2009. Equities do not make up a big proportion of our portfolio - only 15% of our strategic allocation is dedicated to stocks and following a fall in the value of the equities we are down to just 10% - so we expect to reposition ourselves on the equity side soon.
In addition, we are going to increase our position in real estate to 15% of our portfolio from the current 7% exposure. We will wait for the ALM to see how and where to add to that exposure but currently prefer Cypriot real estate.
We will concentrate on traditional asset classes rather than exotic products. In fact we have never invested in outlandish products and I believe that the whole industry is now turning away from them. Our trustees are willing to take risk, but only risk that they understand and that is not too complex. I am also optimistic on bonds, in particular high-yield bonds.
The regulator here has already implemented 95% of the EU’s IORP directive so we expect very few more regulatory changes in the near future that will affect us.
However, the regulator will also support foreign pension funds that - attracted by our low tax ratio - want to register in Cyprus. This may pave the way for the introduction here of pan-European or cross-border pension funds in the future. Our consultants have noticed some interest in registering in Cyprus from some large Greek pension funds, but nothing concrete has been agreed yet.
There is a public debate as to how the recession will affect the tourism industry, in particular as 50% of tourists to Cyprus come from the UK where the recession is expected to be particularly harsh. My personal opinion is that quality hotels with quality products will do well over the long term, while others that do not place so much emphasis on quality may lose some business.
But it is unclear how our pension fund would cope if many members were to lose their jobs as a result of the recession, as this has never happened to Cyprus before. However, out of our 14,500 members, only 8,500 are active. The rest left the industry but have chosen to leave their pension with us.
Peter Moon, chief investment officer at the UK’s Universities Superannuation Scheme (USS), which has invested assets of £26bn (€29.6bn)
We are still in the middle of a bear market and the nature of the problem - essentially the banks’ difficulty in making the financial system work effectively and the perceived need to rebuild their balance sheets - means that we will not return to normal lending patterns for some time. On top of that the repricing of credit affects corporates as well as consumers. In short, the market will take quite a long time to recover and we probably have another two to three years of consumer rehabilitation left.
We are currently having an asset liability management (ALM) study done. However, we do not expect it to significantly change our investment strategy. We are a heavily growth-orientated fund and have around 90% of our benchmark in growth assets, meaning 60% of our portfolio is allocated to equity-type investments, 20% to alternative assets and 10% to property, with the remainder forming our fixed income exposure.
Current prices combined with our strong cashflow now give us an opportunity to buy across the whole spectrum of growth assets, in other words equities, private equity, hedge funds, absolute return vehicles, commodities and infrastructure. So from a long-term view this is a golden opportunity for us to restructure the portfolio at a much higher yield than we would previously have achieved. And so it would not surprise me if our funding level - which was at 77% during the last actuarial evaluation in March 2008 - improved in 2009.
We fund our 20% allocation to alternatives out of our equity holdings, which is why those will decrease in the future. There will also be more of an emphasis on overseas rather than domestic assets, although we might invest in those via futures rather than disturbing the physical portfolios. But overall we will not make any major changes to our asset allocation as a result of the bear market.
The lessons we learnt from this financial crisis are pretty much the same as those we learnt between 1972 and 1974 - that while it is an extremely painful period and although the situation looks pretty dire, at the same time it is important not to become too risk averse.
It took us 15 years to recover from the 1972-74 market and return to the previous peak and the timescale this time will be similar. Nevertheless, as a pension fund our liabilities are of a 40-50-year duration, so 15 years, effectively a third of a working lifetime, is not such a significant time period after all.
We believe that short selling and stock lending actually helps the market in various ways and so we will continue our stock lending programme across the board. If we want to stop lending stocks in a particular company we can easily do that.
I think we are in a unique position among UK pension funds because we have such strong cash flow. Most pension funds are to a large extent liability-driven and will continue to match their liabilities. Fixed interest markets are now suffering from low returns but structured products might alleviate this by achieving a higher return.
Bjarne Graven Larsen, chief investment officer at the Danish labour market supplementary pension scheme ATP, which has invested assets of DKK400bn (€54bn)
We don’t base our investment decisions on our own forecast because we could be wrong when trying to predict the direction of markets.
2009 is very much about looking at the risks that we don’t want to have going forward, in other words cutting off the tail of some distribution costs.
However, we do discuss the economic crisis a lot, debating how severe it is going to be, how long it is going to last and how long it will take the financial sector to get back to normal business. In 2009 we need to be aware of the dynamic of the recapitalisation and leveraging of the banking sector.
We have already had a focus on risk and the balancing of the portfolio in order to desensitise it from potential economic downturns on our agenda in 2007 because we had recognised that a lot of our positions would have done badly had the market turned down then.
We have always strategically hedged our interest rate risk and will continue to do so, which will also help us with risk reduction.
We will try to focus on long-term strategy rather than make too many major tactical decisions and we will retain a balanced portfolio with regard to various high/low growth and high/low inflation scenarios. It really is about having a portfolio that will do well in all kinds of economic circumstances.
Our strategy is to have around 35% of our total risk as equity risk. That is why we have bought some put options as protection.
However, the dynamic of our risk budget is that if we double the volatility we can only have half of the exposure to equities. But if the volatility in equities falls, our equity risk will decline too and then we might decide to buy again. But because we are trying to more or less stick to our long-term strategic risk weighting, we will not buy equities just because they are cheap.
Two years ago we divided the risk into five different classes: equities, including private equity; government bonds; credit products; commodities; and inflation. Since then we have been very focused on keeping a high percentage of the allocation in liquid instruments, which could be turned into cash within a short period. This approach helped us quite a lot in 2008 and so we are retaining it in the new year. We will also be looking for opportunities to increase our exposure to credit because we have been underweight in credit for the past two years.
Danish regulations require pension funds to have surplus capital in order to take investment risks in their portfolio. This system seems to have worked well over the past year as, despite the big losses, Danish pension funds were focused on hedging their liabilities and reducing the risk, and as a result are still over funded.