Pension funds are widely expected to be amongst the last investing institutions to rebalance their portfolios in response to the changing environment created by the euro. Nonetheless, many of the major international fund management houses have made 'euro' portfolios available from 1 January, in recognition of the opportunity for new business.

Wolfgang Heimbach at Deutsche Bank in Frankfurt observes that the process of conversion is already quite advanced with regard to German Spezialfonds, in terms of the number of deutschmark accounts which have been closed and new accounts re-opened for euros.

In terms of institutional pension fund investment, I think you can draw some conclusions from this. Certainly our asset management division is doing a lot of fund reorganisation work and I think it will be very soon that all this will be shifted to the euro," he says, adding, "I think it is understood that the sooner you move, the more competitive advantage you stand to gain."

Zubin Hubner, marketing manager for Merrill Lynch Mercury's international funds, notes that German and Spanish investors have been selling down their mutual funds invested solely in domestic markets in favour of pan-European funds.

"In terms of asset allocation, the amount of money in equity funds in Europe for the three years up to the end of 1997 rose by $350bn (Ecu296bn), or 120%," he says.

Hubner suggests that though the current turmoil in world markets creates a less than perfect environment, liquidity flows should prove resilient given the benign interest rate environment and the expected stimulus of stable currency, notwithstanding the risks if it is too strong.

Pension fund managers are forced to invest most of their money in the currency in which the liabilities will be paid or returns will be measured. A broadening of this remit is inevitable under the euro. The elimination of European currencies and currency matching requirements means 'dom-estic' managers will then be able to rebalance their portfolios away from domestic securities into any euro-denominated securities.

But while the euro investing concept does appear to have gathered quite a momentum, it is perhaps premature to be talking about pension fund trustees putting aside their customary cautionary approach and setting in train a dramatic shift of asset policy. Yes, surveys have shown that the majority will be reconsidering their asset allocation, but when will they act? The question of benchmarking is just one that has not been fully answered.

Frans Ballendux at William M Mercer Klein Hanveld in Amsterdam suggests that there will be some schemes that move quickly to em-brace the changes, while others will move more carefully, and with good reason.

"If they are deciding to change their portfolios, with less emphasis on the domestic market, there's a very full set of issues to be considered."

In terms of the changing capital flows, Morgan Stanley has estimated that around $1,300bn (Ecu1,101bn) worth of new money will flow into European equities as a result of the portfolio rebalancing, between now and 2010. But it is the net outflows that might be of more significance short term.

Markets such as the Netherlands and Ireland are expected to suffer outflows of $47bn and $6.5bn respectively, according to Intersec, as domestic pension funds adopt a wider European asset allocation policy. Perversely, it is the money market-fixated French and Germans whose markets will see the net gains.

Investors, quite correctly, have viewed Europe as a collection of countries with currency and country risk. The euro, in theory, eliminates these risks. Investment, we are told, will henceforth be 'sector-driven' as fund managers choose those industries which match their investment criteria. Furthermore, it is likely that 'sector' investment may take place very quickly and that schemes will, in the first instance, attempt to rebalance their sectors - before they have been able to rebalance the rest of the portfolio.

Howard Flight of fund managers Investec Guinness Flight comments: "I expect stock selection will become increasingly important in a relatively difficult economic environment in the EU". Hubner adds, "The single market/ sector-based approach to constructing portfolios is emerging as the dominant force in equity investment analysis.This has meant a substantial adjustment to the investment process for many." Ballendux says many schemes will not respond to the marketing hype: "There is certainly less urgency on the part of the pension funds. Let's not forget that it is governments and the money managers who are moving ahead."

How will the euro zone affect funds marketing? Obviously a number of the more internationally minded groups, the Americans and the larger European players, believe their ability to offer euro portfolios on a cross-border basis will allow them to gain greater market share. Templeton's business planning director Douglas Adams observes that the euro funds market at the moment is characterised by the dominance of domestic players.

"Sure, there are cross-border players, but if you look at the top five in any country, there is no one who is at the top level in more than one. Deutsche Bank comes close, with substantial operations in the UK and Italy, but it is clear that each market retains distinct characteristics. And yet the change being brought by the euro offers a unique opportunity in that the domestic security sold to the domestic customers will be a 'euro-land' security. There will be domestic institutions that cannot confidently handle substantial foreign investment or cross-border clients. So there's a huge opportunity for those groups with cross-border operations. It gives us a broader canvass."

This idea that nationality of the asset will be of less importance does not, however, hold true for the majority of continental pension schemes. It is unlikely that the restrictions on investment in non-domestic securities will automatically be changed to reflect the creation of Euroland The various restrictions applying in Europe point up the opportunities quite clearly.

Currently for example, no more than 20% of a German pension fund may be invested in foreign assets, across the whole portfolio. In France, it is stipulated that a minimum of 50% should be invested in EU government bonds. In Denmark, no more than 40% may be invested in equities and no more than 20% in unhedged foreign assets. Italian insurance contracts may not invest more than 20% in foreign equities or 50% in foreign bonds.

Adams admits that it is by no means clear to what extent asset allocation will change in the short term: "It may be that even with the euro, pension funds may not be able to invest their assets outside national boundaries, so in that sense it is likely that some investing institutions will lag behind.

"Some will be led by performance - if a country's performance falters, that may encourage pension funds to move a bit faster in freeing up their allocation rules."

Furthermore, the example of other countries may accelerate the euro-isation of pension funds. In time, an entirely new market will form, of investment funds offering products in euros and investment in European companies. The growth of equity investment (and euro-equities in particular) in southern Europe is just one of many factors that will support this. That is why the likes of Fidelity, Deutsche Bank, Mercury, Templeton and State Street are placing so much emphasis on euro-marketing."