Belgium: Thirst for higher yields
Belgian pension schemes are looking ahead to another year of improving funding ratios as they diversify fixed income portfolios, writes Rachel Fixsen
Belgian pension funds reaped healthy returns last year from both equity and bond allocations as central banks added liquidity to world economies.
But while good returns many have boosted funding levels, the country’s pension funds are continuing to diversify fixed-income allocations to guard against risk on the bond side.
“For an investor in euro-zone government bonds and equities, it was a very good year,” says Geert Rosiers, head of institutional clients at Brussels-based KBC Asset Management. The markets were favourable for investors from all sides in 2012, he observes.
As a whole, the market for EMU government bonds returned around 10%, and Belgian government bonds performance even stronger, returning 16%. Corporate bonds, too, produced good profits for investors.
Many observers would have described 2012 as a crisis year due to fears about the future of the euro-zone, but Rosiers points out that European equities in fact returned 15-16% for investors.
Pension funds did not generally make big changes to asset allocation during the year, he observes. “If there was any change at all, it was higher equities and lower cash,” he says.
Kristof Woutters, head of financial engineering and pension solutions expert at Dexia Asset Management in Brussels, describes 2012 as a calmer year for pension fund investment than the ones that preceded it.
“Some pension funds added more money to equities; it was not a big flow, but it might become bigger in 2013,” he suggests. “There is now some more interest in going into emerging markets, because it is clear that these are growing economies,” he says.
According to provisional data from the Belgian Association of Pension Institutions (BVPI), Belgian pension funds increased equity allocations at the expense of bond holdings in the second half of last year.
Between June and December 2012, equity allocations rose to 37% from 34%, while bond holdings fell to 49% from 53%.
Within bonds there was a notable shift from government bonds to corporate bonds.
“For the first time ever, corporate bonds now have a larger weight than government bonds,” observes Mark Desmet, head of institutional sales, Belgium at BNP Paribas Investment Partners (BNPPIP).
BNPPIP has certainly observed more appetite for corporate bonds versus government bonds, he says. “We also see an increased interest in emerging debt, a demand to invest in government bonds on a global basis and no longer on a euro basis, and more recently interest in loans.”
Looking ahead to the rest of 2013 and beyond, Desmet predicts pension funds will diversify further and continue to re-consider the “non-risky” part of the portfolio. “No asset class is without risk any more,” he cautions.
The Belgacom pension fund – currently diversifying its own fixed income portfolio – sees fixed income as potentially the first source of risk in overall asset allocation, given today’s floor-level yields.
Rosiers believes that Belgian pension funds generally will need to take further action in 2013 to spread risk in fixed income allocation.
“They still have a high proportion of government bonds, especially those denominated in euros where yields are very low,” he comments. “We think they should further diversify towards emerging market debt and corporate bonds.”
The outlook for emerging markets is good, with yields still higher than from those governments in the developed world. On top of this, he suggests investors can potentially make gains from currency appreciation.
However, investment limits could pose problems. “Many Belgian pension funds are prepared to take the currency risk in equities, but when it comes to fixed income, they often have the restriction that this should all be in euro,” Rosiers says.
KBC Asset Management is trying to persuade its pension fund clients that they should relax this restriction.
“A lot of developed countries have had ratings downgrades, but emerging market issuers are having the opposite, so a lot of things are changing,” he says.
But he acknowledges that pension fund boards may take time to be convinced about this changing pattern.
Woutters sees pension funds now keener to put money into non-investment grade bonds, as part of the thirst for higher yields.
“In Belgium, the average discount rate was slightly over 5% in 2011, which is the highest discount rate anywhere in Europe,” he says.
“On the one hand, this is a huge advantage for a pension fund, because it means you have virtual lower liabilities.
“But on the asset side, if the pension fund doesn’t achieve at least this on its assets, then its funding ratio come under pressure,” he says.
This high discount rate continues to attract debate in Belgium, he says, adding that the rate is bound to change when IORP II is implemented.
The new European pensions directive will make schemes safer for members, Woutters says, because it will force sponsors to make up shortfalls at occupational schemes.
But the upcoming IORP II framework is a double-edged sword for Belgian pension funds, he remarks.
“On the one hand, they will want to have relatively high expected returns close to the current discount rate of about 5%, which will mean taking on more risk – such as with equity investments – but on the other, the framework will include certain capital requirements which will mean investing in equities will carry the highest capital charges,” he says.
Belgian pension funds make little use of alternative investments, he finds.
“This has to do with the average size of funds, at €40-50m, which means they are not generally managed by a dedicated team at the sponsor level, so there is not much sophistication and therefore not much capacity for alternatives investment.”
Funding levels at individual pension funds in Belgium may change this year, but the direction will depend on whether the fund concentrates on the short or long-term funding figure, Rosiers explains.
“In the short term, we think funding levels will end up higher this year,” he says. “But with the longer-term funding ratio – and certainly if you discount your liabilities by market yield – there’s a risk that your funding level will be even worse than last year.”
Increasingly, pension funds are trying to reduce the volatility of their investment portfolios, because of the negative impact these swings have on the balance sheet of their sponsors, Rosiers finds.
Many are attempting to achieve this by investing in equities, but choosing equity investments that result in lower volatility, he says.