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Impact Investing

IPE special report May 2018

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Funds aware of rising risk

One of Belgium’s largest funds, KBC, has come through the bad years of 2001 and 2002 to produce a return of over 11% last year. “This made good almost all of the losses suffered in previous years,” says KBC’s managing director Edwin Meysmans. “But the losses have brought the funding level down from 160% three years ago to 120% today.”
He adds: “Through the bad years we stuck to our strategic asset allocation which, for a Belgian fund, is overweight in equities,” Right now the market has 45% in equities compared with KBC’s 57%, which includes private equity. We also have 36% in bonds and 7% real estate. We don’t have anything invested in hedge funds but we are examining the possibility in an ALM study.
“We have stuck to this asset allocation since the last ALM in 2001. We are updating it right now and will implement our new strategic asset allocation as of 2005.”
He adds: “That means that we are responsible for the guarantee of a return of 3.25%. It’s not that much and there is no reason for panic because even after three difficult years we are nearly 100% funded. That’s a pretty good result.”
In order to stimulate the development of second pillar pension provision in Belgium legislation has been introduced to encourage industry-wide, sector schemes; they have to achieve a return of 3.25% but only over the lifetime of the fund. As many funds have only just become operational, contribution levels are tiny and fund sizes are small; this in turn limits the scope for risk in the portfolio.
The metal workers’ scheme was one of the first sector schemes to be set up and being now one of the largest funds it has more scope for risk. When the fund started 60% was invested in bonds and 40% in equities.
“The aim was then to reverse the proportions but during the last three difficult years we went to 70% bonds and 30% equities. In the last half year allocation was again at 40% equities and 60% bonds,” notes Fritz Potemans, social adviser to Agoria, the employers organisation of the metal workers’ and technology industries, which together with the metal workers’ unions, runs the pension fund for the metal workers. The sector funds are all defined contribution (DC).
Both of KBC’s schemes have around E700m of assets under management; DC schemes account for around E70m. The proportion of DC schemes managed by KBC will increase because more DC schemes are becoming compulsory.
Meysmans of KBC cites two demands that are coming from the sponsor: less volatility and less cost. “The issue is how to combine those,” he says. “If we switch to fixed income that will drive up cost, so we could reduce equity and go into alternatives.
Another option is to stay at a high level of equities but through the use of derivatives and other structured products buy some protection from the downside. We avoid the high cost by staying with high equities and control downside. We definitely expect to see this happening in the market.”
No spectacular changes in asset allocation are expected for Belgian pension funds. In general funds have become more risk averse as a result of the erosion of reserves brought about by the poor performance of the equity markets. “But at the same time they realise that at current interest rates more bonds will not do the trick to generate the return needed for the liabilities that lay ahead,” says Jo Steenhaut at
KBC AM.
He adds: “Hence, the equity component in strategic asset allocation with Belgian pension funds remains rather constant at 50% to 52% on average. What we do see is that the increased risk awareness has inspired pension funds to invest in capital protected instruments. In this product range pension funds see possibilities to participate in equity markets without the downside risk over a certain period or to hedge their bond portfolio against rising interest rates.”
KBC also noticed a rising interest in non-correlated investments such as Japanese equities, corporate bonds and inflation linked bonds.
Where regulation is concerned, one of the concerns is the accounting legislation. “IAS can push pension funds to more conservative investments and eventually drive the employers towards insured schemes, whose returns are unexciting but secure,” says Hervé Noël, head of employee benefits at Tractabel. “If you have to abandon the flexibility then what is the point of investing through a pension fund?”
Noël highlights two regulatory concerns. The first relates to the preservation of what he describes as "corridor" possibilities which allow funds to smooth discrepancies between reality and assumptions. “This is useful because you don’t need to reflect fully in the company’s accounts what happens with the investments,”
he says. “
If that is going to disappear then the reaction of the sponsor will be to take less risk because he doesn’t want to see all that volatility reflected fully in his accounts.” The “corridor” possibilities are under threat because of the IAS accountancy board and FRS17.
On a European level discrimination by pension funds on grounds of factors such as age and gender will be abolished. “Clarification of the discrimination issues is badly needed,” says Noël. “We do not know the implications of the legislation; there is much uncertainty. For example, if someone has a two-year contract and it is not worthwhile to include them in the pension scheme, is that compliant with the anti-discrimination laws? We don’t know. Do we have to apply unisex tables? Again, we don’t know.”

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