Caution is king
BVV is Germany’s largest Pensionskasse with total assets of €16.9bn at the end of 2004, according to data from the German regulator BaFin. Total assets were nearly three times their level in 1990 and also make BVV nearly three times the size of its nearest rival; BVV’s membership stood at just under 400,000 in the banking and finance sector.
The stock market crash and the unpredictability of returns has made absolute return central to BVV’s investment strategy. “For many years we have been less benchmark orientated and very focused on absolute return,” says BVV board member and CFO Rainer Jakubowski. “The past has shown that it doesn’t help if our performance is a few points above the benchmark but still negative.”
He adds: “Within this framework we invest in corporate bonds and hedge funds. We also plan to introduce into the portfolio global bonds with an absolute return function as well as private equity.”
Diversification, given BVV’s focus on risk, is a key underlying principle. “For us diversification is the only way to reduce risk without incurring costs,” Jakubowski explains.
The diversification extends to managers. “We have already achieved a good level of manager style diversification which we are pursuing further.”
It is interesting that despite the encouraging development of the stockmarket, equities still account for a much smaller part of German pension fund portfolios than is the case elsewhere in Europe. So is it not the case that pension funds in other countries that have more invested in equities are better positioned to benefit from the growth in equity markets and thus deliver better returns? “That is correct,” says Jakubowski. “On account of the regulations pension funds in Germany and the stress tests that we, along with other pension funds have to undergo, allocations to equities among German pension funds are relatively low. During the years when stock markets rose BVV had an allocation to equities that was slightly over the average.”
BVV also has to achieve an annual return of 2.75% on pension contracts with new employees and up to 4% on existing pension contracts. “This is challenging due to the current environment of low interest rates but we also need to make sure that we don’t take too much risk,” Jakubowski stresses.
There are plans to reduce the minimum interest rate guarantee of 2.75% to 2.25%. “This is in line with the change in the market environment,” says Jakubowski. “It is not so significant for us because we still have to deliver 4% for much of the existing pension assets. It will be many years before the 2.25% rate becomes significant.”
Jakubowski insists that BVV has profited from the positive developments in equity prices by having increased the allocation to equities of more than 12% of the portfolio, which is above the national average. “At the beginning of 2005 we invested in Japanese equities for the first time and later in the year issued an Asian equities mandate,” he says. “We also issued new small and mid-cap mandates. We have implemented considerable diversification through our equity portfolio.”
He adds: “We are also very interested in any product innovations that come onto the market - for example new structured products. We also looked at alternative products as soon as they came onto the market.”
Liability driven investing, though not a requirement in Germany, is now a subject of discussion in a number of pension fund board rooms across the country. Although no specific LDI strategy has been implemented at BVV, Jakubowski notes: “We have always been very focused on our liabilities in the formulation of our investment strategy and that will continue. However, we have had no interest at all in life-cycle investing. As soon as there is an interest we would consider it.”
BVV carries out some asset management internally but outsources all asset classes that are research-intensive such as corporate bonds, equities, hedge funds and global bond mandates. “These require infrastructure and specialist personnel and we have decided to use external managers rather than bringing the necessary resources in-house,” Jakubowski notes.
The choice of an investment manager is a considerable task for all pension funds whether they perform the task themselves or outsource to a consultant. “After an initial screening there are several stages including visits to the asset managers under consideration where we look at the individual managers,” says Jakubowski. “On the whole we are satisfied with our choice of managers. Occasionally we are disappointed with a manager but in such cases we find a replacement.”
He adds: “In our choice of managers we always favour our member companies and this includes foreign companies with German subsidiaries. But most well known banks and asset managers are member companies. So we have a huge choice of good managers to choose from.”
But what about a new manager that has performed well but is not member of BVV? “We consider all managers but preference is given to member companies,” Jakubowski explains.
BVV only rarely has reason to use the services of a consultant. “There are certain functions which we consider core and these include the selection of managers, risk control and investment strategy,” Jakubowski explains. “Here we would only use a consultant in exceptional cases, and where we have we have done we have always been satisfied. For other functions we may use a consultant - for example we have just finished the search for a global custodian.”
The second pillar in Germany is growing steadily and measures have been taken over the years to stimulate its development. BVV director Friedhelm Dresp is upbeat but has concerns. “I believe that the second pillar must and indeed will become more significant given that the level of first pillar provision will decline,” he says. “I am in favour of all measures taken to stimulate the second pillar but hope that regulation will not be excessive. We still need a balance in terms of the level of risk which pension funds will be able to use and we would benefit from an increase in the tax incentives for contributions to second pillar schemes although I am sure that the discussion on that subject is heading in the right direction.”
At BVV feelings about the European pensions directive are mixed. Dresp notes: “We see as positive the effect on the German system of the European Pensions Fund Directive but feel that it is too heavy on regulation.”
The coming year holds a number of challenges for BVV. Jakubowski notes: “This year will be a more challenging year in the capital markets than last year.”
An ongoing challenge is the restructuring which is taking place across the banking sector in Germany which has made necessary some major new strategic thinking at BVV. “Given the fall in our core membership due to redundancies in the industry, expansion into new areas of business is top of the agenda,”
Jakubowski explains. “One new area of business will be to take over pension administration for some of our clients who operate the direct promise book reserve system. This will be launched within the next few months.“